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International Tax Agreements Amendment Bill 1999

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1998-99

 

The Parliament of the Commonwealth of Australia

 

 

 

HOUSE OF REPRESENTATIVES

 

 

 

INTERNATIONAL TAX AGREEMENTS AMENDMENT BILL 1999

 

 

 

 

 

Explanatory memorandum

 

 

 

 

 

(Circulated by authority of the

Treasurer, the Hon Peter Costello, MP)

 



General outline and financial impact.............................................. 1

Chapter 1   Agreement with the Republic of South Africa.......... 13

Chapter 2   Amending protocol to the agreement with Malaysia 49

Chapter 3   Agreement with the Slovak Republic....................... 63

Chapter 4   Agreement with the Argentine Republic................... 95

Chapter 5   Regulation Impact Statements................................ 135

Australia-South Africa Double Taxation Agreement ............ 135

Protocol to the Australia-Malaysia Double Tax Agreement

and the exchange of Letters to extend tax sparing ............... 144

Australia-Slovak Republic Double Tax Agreement............... 149

Australia-Argentina Double Tax Agreement........................... 157

 

 

 



What do we mean by double taxation?

Australia’s Double Taxation Agreements (DTAs) are primarily concerned with relieving juridical double taxation, which can be described broadly as subjecting the same income derived by a taxpayer during the same period of time to comparable taxes under the taxation laws of 2 different countries.

Why are DTAs necessary?

Relief from double taxation is desirable because of the harmful effects double taxation can have on the expansion of trade and the movement of capital and people between countries. A DTA supplements the unilateral double tax relief provisions in the respective treaty partner countries’ domestic law and clarifies the taxation position of income flows between them.

How do the DTAs work?

The DTAs allocate to the country of source, sometimes at limited rates, a taxing right over various income, profits or gains. It is accepted that both countries possess the right to tax the income of their own residents under their own domestic laws and as such, the DTA wording will not always explicitly restate this rule.

However, where the country of residence is to be given the sole taxing right over certain types of income, profits or gains, this sole right is usually represented by the words shall be taxable only in that country . The agreement also provides that where income, profits or gains may be taxed in both countries, the country of residence (if it taxes) is to allow double tax relief against its own tax for the tax imposed by the country of source. In the case of Australia, effect is given to the relief obligations arising under the DTA by application of the general foreign tax credit system provisions of Australia’s domestic law, or relevant exemption provisions of the law where applicable.

What is the purpose of Australia’s DTAs?

Australia’s DTAs are designed to:

(a)     Prevent double taxation and provide a level of security about the tax rules that will apply to particular international transactions by:-

·          allocating taxing rights between the countries over different categories of income;

·          specifying rules to resolve dual claims in relation to the residential status of a taxpayer and the source of income; and

·          providing, where a taxpayer considers that taxation treatment has not been in accordance with the terms of a DTA, an avenue for the taxpayer to present a case for determination to the relevant taxation authorities.

(b)     Prevent avoidance and evasion of taxes on various forms of income flows between the treaty partners by:

·          providing for the allocation of profits between related parties on an arm’s length basis;

·          generally preserving the application of domestic law rules that are designed to address transfer pricing and other international avoidance practices; and

·          providing for exchanges of information between the respective tax authorities.

How is the legislation structured?

DTAs to which Australia is a party appear as Schedules to the International Tax Agreements Act 1953 (the Agreements Act). The Agreements Act gives the force of law in Australia to those DTAs. The provisions of the Income Tax Assessment Act 1936 (ITAA 1936) and the Income Tax Assessment Act 1997 (ITAA 1997) are incorporated into and read as one with the Agreements Act. In any cases of inconsistency, the Agreements Act provisions (including the terms of the DTAs) generally override the ITAA 1936 and the ITAA 1997 provisions.

What will this Bill do?

This Bill will amend the Agreements Act to give the force of law in Australia to the following treaties:

·          the Agreement between the Government of Australia and the Government of the Republic of South Africa for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income ( the South African agreement );

·          a Protocol ( the Malaysian protocol ), amending the Agreement between the Government of Australia and the Government of Malaysia for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income of 20 August 1980 (the 1980 Agreement);

·          the Agreement between the Government of Australia and the Government of the Slovak Republic for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income ( the Slovak agreement );

·          the Agreement between the Government of Australia and the Government of the Argentine Republic for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income ( the Argentine agreement ).

Who will be affected by the measures in this Bill?

Any taxpayers who, for the purposes of:

·          the South African agreement are residents of Australia or South Africa, and who derive income, profit or gains from Australia or South Africa;

·          the 1980 Malaysian Agreement (including the Malaysian protocol ), are residents of Australia or Malaysia, and who derive income, profit or gains from Australia or Malaysia;

·          the Slovak agreement are residents of Australia or the Slovak Republic, and who derive income, profit or gains from Australia or the Slovak Republic;

·          the Argentine agreement are residents of Australia and Argentina, and who derive income, profit or gains from Australia or Argentina.

In what way does this Bill change the Act?

This Bill will make the following changes to the Agreements Act:

·          it will insert into subsection 3(1) definitions of the South African agreement, the Malaysian protocol, the Slovak agreement and the Argentine agreement ;

·          it will insert new sections 11ZG, 11FA, 11ZH and 11ZI which will give the force of law in Australia to those treaties;

·          it will insert a provision in the Agreements Act which will allow the Commissioner of Taxation (the Commissioner) to amend assessments made before the entry into effect of the Malaysian protocol where those assessments are affected by the retrospective operation of:

-           Article 2 (fees for technical services); or

-           Article 9 (allowance of tax credits for tax sparing relief and the underlying tax paid in respect of non-portfolio dividends),

of that Protocol which benefit Australian taxpayers;

·          it will insert a provision in the Agreements Act, which will allow the Commissioner to amend assessments made before the entry into effect of the Argentine agreement where those assessments are affected by the retrospective operation of Article 8 and paragraph 4 of Article 13 concerning airline profits; and

·          it will add the text of each treaty as Schedules 42, 16A, 43 and 44 respectively.

When will these changes take place?

Each of the treaties will enter into force on the last of the dates on which the treaty partners exchange notes through the diplomatic channel advising each other that all domestic requirements necessary to give the respective treaties the force of law in the respective countries have been completed.

When the treaties enter into force, from what date will they have effect?

The South African agreement will have effect:

In Australia :

·          for withholding tax on dividends, interest and royalties, on or after 1 January next following that in which the DTA enters into force; and

·          for other Australian taxes covered by the DTA, in respect of income, profits or gains of any year of income beginning on or after 1 July in the calendar year next following that in which it enters into force.

In South Africa :

·          for taxes withheld at source from amounts paid or credited, on or after 1 January next following the date on which the DTA enters into force; and

·          for other South African taxes covered by the DTA, in respect of years of assessment beginning on or after 1 January next following that in which it enters into force.

The Malaysian protocol will have effect:

In Australia :

·          subject to sub-paragraph 1(a)(ii) of Article 10 of the Protocol, for the purposes of Article 9 of the Protocol (relating to tax sparing relief and underlying tax credits) in respect of tax on income of any year of income beginning on or after 1 July 1987;

·          to the extent that Article 9 of the Protocol has application in respect of Malaysian tax forgone in accordance with section 35 or 37 of the Promotion of Investments Act 1986 of Malaysia, in respect of tax on income of any year of income beginning on or after 1 July 1985;

·          for the purposes of sub-paragraph (c) of Article 2 of the Protocol, (relating to fees for technical services) in respect of tax on income of any year of income beginning on or after 1 July 1993; and

·          in any other case, in relation to income of any year of income beginning on or after 1 July in the calendar year next following that in which the Protocol enters into force.

In Malaysia :

·          for the purposes of Article 9 of the Protocol, in respect of tax for any year of assessment beginning on or after 1 January 1988;

·          in the case of sub-paragraph (c) of Article 2 of the Protocol, in respect of tax for any year of assessment beginning on or after 1 January 1994; and

·          in any other case, in respect of tax for any year of assessment beginning on or after 1 January in the second calendar year following the calendar year in which the Protocol enters into force.

The Slovak agreement will have effect:

In Australia :

·          for withholding tax on dividends, interest and royalties, on or after 1 January in the calendar year following the year in which the DTA enters into force; and

·          for other Australian taxes covered by the DTA imposed on income, profits or gains of any year of income beginning on or after 1 July in the calendar year next following the year in which the DTA enters into force.

In the Slovak Republic :

·          for tax withheld at source, on amounts derived on or after 1 January in the calendar year following the year in which the DTA enters into force; and

·          for other Slovak taxes covered by the DTA chargeable for the taxable years (income years) beginning on or after 1 January in the calendar year next following that in which the DTA enters into force.

The Argentine agreement will have effect:

In Australia :

·          for withholding tax on dividends, interest and royalties, on or after 1 January in the calendar year next following that in which the DTA enters into force; and

·          for other Australian taxes covered by the DTA, in respect of income, profits or gains of any year of income beginning on or after 1 July in the calendar year next following that in which the DTA enters into force.

In the Argentine Republic :

·          for all taxes withheld at source, on income derived on or after 1 January in the calendar year next following that in which the DTA enters into force; and

·          for other Argentine taxes covered by the DTA, in respect of tax chargeable for any tax year beginning on or after 1 January in the calendar year next following that in which the DTA enters into force.

In both Australia and the Argentine Republic :

·          for income, profits or gains from the operation of aircraft, in respect of tax on such income, profits or gains of any year of income beginning on or after 27 September 1988 (being the date from which direct air services operated between Australia and Argentina).

The financial impact of this Bill

The South African agreement, the Slovak agreement and the Argentine agreement

The new comprehensive DTAs contained in this Bill generally accord with Australia’s other modern comprehensive DTAs and are not expected to have a significant effect on revenue.

The Malaysian protocol

As with DTAs generally, it is not possible to quantify with any degree of precision the likely revenue effect of the Protocol. Much will depend on the balance of income flows that will be affected and other factors. For example, the tax likely to be forgone by the Australian Revenue by the continuation to the 1991-1992 income year of tax sparing credits for the Malaysian tax incentives will be dependent on such things as the amount of the Malaysian tax reduction or exemption applicable in respect of the particular income, the quantum of that income, and the number of taxpayers affected, none of which can be determined with any degree of certainty.

In relation to the fees for technical services provision, it is unlikely there will be a cost to the Australian Revenue because in most cases the affected Australian residents will continue to be liable to tax in Australia (most of them do not have a permanent establishment in Malaysia) on the fees for technical services that they provide to Malaysian residents.

Subject to the above qualifications, an annual cost to Australia’s Revenue of around $1 to 2 million is estimated.

Compliance costs

No significant additional compliance costs will result from the entry into force of the respective treaties.

Summary of Regulation Impact Statements (RIS)

The South African Agreement

Impact:  Low.

Main points :  A DTA with South Africa is likely to have an impact on Australian residents with business, investment or employment interests in South Africa.

Financial impact :  Minor.

Assessment of benefits

·          Nil withholding tax will be imposed by either Australia or South Africa on dividends flowing from subsidiary companies to parent companies in the other country, if they are fully franked and if the parent holds at least 10% of the capital of the subsidiary. In any other case, the rate will be 15%.

·          A source country tax rate limit of 10% will generally apply for both countries in the case of interest and royalties.

·          The DTA recognises the creditability of the South African secondary company tax, and accordingly provides credits for underlying taxes, where applicable, in respect of dividends derived by Australian companies from South African companies.

·          The DTA will also assist in making clear the taxation arrangements for pensions and annuities and for individual Australians working in South Africa, either independently as consultants, or as employees.

·          The DTA will assist the bilateral relationship by adding to the existing network of commercial treaties between the 2 countries.

Policy objective :  The objective is to promote closer economic cooperation between Australia and other countries by eliminating possible barriers to trade and investment. The DTA will reduce or eliminate double taxation of income flows between the treaty partner countries caused by overlapping tax jurisdictions. The DTA will also establish greater legal and fiscal certainty within which cross-border trade and investment can be carried on and promoted.

Another objective is to create a framework for exchange of information and cooperation between the respective tax administrations as a means of combating international tax avoidance and evasion.

The RIS was tabled in Parliament on 11 August 1999.

The Malaysian Protocol

Impact :  Low.

Main points :   The Malaysian Protocol will impact on Australian residents doing business with Malaysia, including principally:

·          Australian residents supplying consultancy services and technology and know-how to Malaysian residents;

·          Australian residents investing in, lending to and receiving royalty income from Malaysia.

Financial impact :  Minor.

Assessment of benefits :  Australian residents who are in receipt of fees for technical services paid by Malaysian residents will benefit because such fees will no longer be double taxed.

Clarification of which Malaysian development tax incentives qualify for tax sparing and the extension of those provisions will reduce costs for Australian investors who have taken advantage of Malaysia’s development incentives.

Policy objective :  The Protocol overcomes the double taxation situation currently facing Australian residents who are in receipt of fees for technical services paid by Malaysian residents. The Protocol will also update the existing DTA in a number of respect to bring it into line with Australia’s current law and treaty policies and practices.

The RIS was tabled in Parliament on 11 August 1999.

The Slovak Agreement

Impact :  Low.

Main points :  A DTA with the Slovak Republic is likely to have an impact on Australian residents with business, investment or employment interests in the Slovak Republic.

Financial impact :  Minor.

Assessment of benefits :

·          The dividend withholding tax rate imposed by Australia and the Slovak Republic shall be reduced to 15% of the gross amount of dividends paid by a company which is a resident of one Contracting State, to a resident of the other Contracting State who is beneficially entitled to those dividends.

·          A source country tax rate limit of 10% will generally apply for both countries in the case of interest and royalties.

·          The DTA will also assist in making clear the taxation arrangements for individual Australians working in the Slovak Republic, either independently as consultants, or as employees.

·          The DTA will assist the bilateral relationship by adding to the existing network of commercial treaties between the 2 countries.

Policy objective :  The objective is to promote closer economic cooperation between Australia and other countries by eliminating possible barriers to trade and investment. The DTA will reduce or eliminate double taxation of income flows between the treaty partner countries caused by overlapping tax jurisdictions. The DTA will also establish greater legal and fiscal certainty within which cross-border trade and investment can be carried on and promoted.

Another objective is to create a framework for exchange of information and cooperation between the respective tax administrations as a means of combating international tax avoidance and evasion.

The Argentine Agreement

Impact :  Low.

Main points :  A DTA with the Argentine Republic is likely to have an impact on Australian residents with business, investment or employment interests in the Argentine Republic.

Financial impact :  Minor.

Assessment of benefits :

·          Most Argentine royalty withholding taxes will fall from 24% to 10% or 15%, thereby making Australian suppliers of technology and capital more competitive.

·          The DTA will limit taxation of dividends paid to Australian shareholders.

·          In particular, the mining industry should benefit from the provisions contained in the new DTA.

·          The treaty will also assist in making clear the taxation arrangements for individual Australians working in Argentina, either independently as consultants, or as employees. Income from professional services and other similar activities provided by an individual will generally be taxed only in the country in which the recipient is resident for tax purposes except in certain circumstances where the services are rendered in the other country.

·          Although the DTA permits Argentina to impose a contractors’ withholding tax on payments of technical services fees by Argentine residents, the DTA reduces the Argentine (monetary) rates from its domestic rates of 18% to 27% of gross payments to 10% of net fees.

·          A most favoured nation clause of the DTA ensures that if Argentina were to subsequently enter into another treaty with a third party with more favourable tax rates for dividends, interest, royalties or contractors’ withholding taxes, the corresponding tax rate in the DTA would automatically be reduced to coincide with the greater of the lower rate or the set minimum limit.

Policy objective :  The objective is to promote closer economic cooperation between Australia and other countries by eliminating possible barriers to trade and investment. The DTA will reduce or eliminate double taxation of income flows between the treaty partner countries caused by overlapping tax jurisdictions. The DTA will also establish greater legal and fiscal certainty within which cross-border trade and investment can be carried on and promoted.

Another objective is to create a framework for exchange of information and cooperation between the respective tax administrations as a means of combating international tax avoidance and evasion.

 



C hapter

Agreement with the Republic of South Africa

Main features of the Double Tax Agreement

1.1         The agreement between Australia and South Africa accords substantially with Australia’s recent comprehensive double taxation agreements (DTAs). A number of modifications to the provisions have been required to accommodate South Africa’s domestic territorial taxation system.

1.2         The features of the DTA include:

·          Dual resident individuals (i.e. persons who are residents of both Australia and South Africa according to the domestic law of each country) are, in accordance with specified criteria, to be treated for the purposes of the DTA as being residents of only one country.

·          Income from real (immovable) property may be taxed in full by the country in which the property is situated. Income from real property for these purposes includes natural resource royalties.

·          Business profits are to be generally taxed only in the country of residence of the recipient unless they are derived by a resident of one country through a branch or other prescribed ‘permanent establishment’ in the other country, in which case that other country may tax the profits.

·          Profits from international operations of ships and aircraft may be taxed only in the country of residence of the operator.

·          Profits of associated enterprises may be taxed on the basis of dealings at arm’s length.

·          Dividends, interest and royalties may generally be taxed in both countries, but there are limits on the tax that the country in which the dividend, interest or royalty is sourced may charge on such income flowing to residents of the other country who are beneficially entitled to that income. These limits are 10% for interest and 10% of royalties. No tax is payable in the source country on dividends which have been fully taxed at the corporate level where the dividend recipient is a company that holds directly at least 10% of the capital of the company paying the dividend. A 15% limitation on source country tax applies to all other dividends.

·          Income, profits or gains from the alienation of real property may be taxed in full by the country in which the property is situated. Subject to that rule and other specific rules in relation to business assets and some shares, capital gains are to be taxed in accordance with the domestic law of each country.

·          Income from professional services and other similar activities provided by an individual will generally be taxed only in the country of residence of the recipient. However, remuneration derived by a resident of one country in respect of professional services rendered in the other country may, where that remuneration is derived through a fixed base of the person concerned in that country or if the person is present for more than 183 days in any 12 month period in that country, be taxed in that country.

·          Income from dependent personal services , that is, employee’s remuneration, will generally be taxable in the country where the services are performed. However, where the services are performed during certain short visits to one country by a resident of the other country, the income will be exempt in the country visited.

·          Directors’ fees and other similar payments may be taxed in the country of residence of the paying company.

·          Income derived by entertainers and sportspersons may generally be taxed by the country in which the activities are performed.

·          Pensions and annuities (excluding government service pensions) may be taxed only in the country of residence of the recipient provided that such pensions and annuities are included in the taxable income in that country. However, an annuity paid to a former resident of a country which was purchased by way of a lump sum payment from an insurer in that country may be taxed by both countries, with the country of residence of the recipient providing double tax relief.

·          Government service remuneration will generally be taxed only in the country that pays the remuneration. However, the remuneration may be taxed in the other country in certain circumstances where the services are rendered in that other country. Similarly, government service pensions will generally be taxed only in the paying country. However, if the pensioner is both a resident, and a citizen or national, of the other country and the services for which the pension is paid were rendered in that other country, the pension will be taxable only in that other country.

·          Income of visiting students will be exempt from tax in the country visited insofar as it consists of payments made from abroad for the purposes of their maintenance or education.

·          Other income (i.e. income not dealt with by other articles) may generally be taxed in both countries, with the country of residence of the recipient providing double tax relief.

·          Double taxation relief for income which under the DTA may be taxed by both countries is required to be provided by the country in which the taxpayer is resident under the terms of the DTA as follows:

-           in Australia , by allowing a credit for South African tax against Australian tax payable on income derived by a resident of Australia from sources in South Africa. Australia is also required to give credit for underlying taxes on non-portfolio dividends paid to related Australian resident companies;

-           in South Africa , by deducting the Australian tax paid from the South African tax due on income derived by residents of South Africa from sources in Australia.

·          In the case of Australia, effect will be given to the double tax relief obligations arising under the DTA by application of the general foreign tax credit system provisions of Australia’s domestic law, or relevant exemption provisions of that law where applicable.

·          Consultation and exchange of information between the 2 taxation authorities is authorised by the DTA.

Agreement with South Africa

Article 1 - Personal scope

Scope

1.3         This article establishes the scope of application of the DTA, by providing for it to apply to persons (defined to include companies) who are residents of one or both countries. It generally precludes extra-territorial application of the DTA.

1.4         The application of the DTA to persons who are dual residents (i.e. residents of both countries) is dealt with in Article 4.

Article 2 - Taxes covered

Taxes covered

1.5         This article specifies the existing taxes of each country to which the DTA applies. These are, in the case of Australia:

·          the Australian income tax; and

·          the resource rent tax in respect of offshore petroleum projects.

1.6         It is specifically stated that the article applies only to taxes imposed under the federal law of Australia. This is to ensure that the DTA does not bind Australian States and applies only to federal taxes.

1.7         For South Africa the DTA applies to:

·          the normal tax; and

·          the secondary tax on companies.

1.8         In the case of Australia, income tax (including that imposed on capital gains), and resource rent tax are covered by the DTA. Sales tax, goods and services tax, fringe benefits tax, wool tax and levies, customs duties, State tax and duties and estate tax and duties are not covered by the DTA.

Substantially similar taxes

1.9         The application of the DTA will be automatically extended to any identical or substantially similar taxes which are subsequently imposed by either country in addition to, or in place of, the existing taxes. A duty is imposed on Australia and South Africa to notify each other within a reasonable time of any significant changes to their respective laws to which the DTA applies.

Article 3 - General definitions

Definition of Australia

1.10       As with Australia’s other modern taxation agreements, Australia , when used in a geographical sense, is defined to include certain external territories and areas of the continental shelf. By reason of this definition, Australia preserves its taxing rights, for example, over mineral exploration and mining activities carried on by nonresidents on the seabed and subsoil of the relevant continental shelf areas (under section 6AA of the Income Tax Assessment Act 1936 (ITAA 1936), certain sea installations and offshore areas are to be treated as part of Australia). The definition is also relevant to the taxation by Australia and South Africa of shipping profits in accordance with Article 8 of the DTA. [Sub-paragraph 1(a)]

Definition of company

1.11       The definition of company in the DTA accords with Australia’s DTA practice. It reflects the fact that Australia’s domestic tax law does not specifically use the expression body corporate for tax purposes.

1.12       The Australian tax law treats certain trusts (public unit trusts and public trading trusts) and corporate limited partnerships as companies for income tax purposes. These entities will be regarded as companies for the purposes of the DTA. [Sub-paragraph 1(e)]

Definition of international traffic

1.13       In this DTA this term is of relevance only for alienation of ships and aircraft (Article 8.3) and wages of crew (Article 15.3). [Sub-paragraph 1(i)]

Definition of tax

1.14       For the purposes of the DTA, the term tax does not include any amount of penalty or interest imposed under the respective domestic law of the 2 countries. This is important in determining a taxpayer’s entitlement to a foreign tax credit under the double tax relief provisions of Article 23 of the DTA. [Sub-paragraph 1(k)]

1.15       In the case of a resident of Australia, any penalty or interest component of a liability determined under the domestic taxation law of South Africa with respect to income that South Africa is entitled to tax under the DTA, would not be a creditable tax for the purposes of Article 23.1 of the DTA. This is in keeping with the meaning of foreign tax in the ITAA 1936 (subsection 6AB(2) - Foreign Income and Foreign Tax). Accordingly, such a penalty or interest liability would be excluded from calculations when determining the Australian resident taxpayer’s foreign tax credit entitlement under Article 23.1 (pursuant to Division 18 of Part III of the ITAA 1936 - Credits in Respect of Foreign Tax).

Terms not specifically defined

1.16       Where a term is not specifically defined within this DTA, that term (unless used in a context that requires otherwise) is to be taken to have the same interpretative meaning as it has under the domestic law of the country applying the DTA at the time of its application, with the meaning it has under the taxation law of the country having precedence over the meaning it may have under other domestic laws.

1.17       If a term is not defined in the DTA, but has an internationally understood meaning in double tax treaties and a meaning under the domestic law the context would normally require that the international meaning be applied. [Paragraph 2]

Article 4 - Residence

Residential status

1.18       This article sets out the basis by which the residential status of a person is to be determined for the purposes of the DTA. Residential status is one of the criteria for determining each country’s taxing rights and is a necessary condition for the provision of relief under the DTA. The concept of resident according to each country’s taxation law provides the basic test.

1.19       A person is not a resident of Australia for the purposes of the DTA if that person is liable to tax in Australia in respect only of income from sources in Australia. The provision means that Norfolk Island residents, who are generally subject to Australian tax on Australian source income only, will not be residents of Australia for the purposes of the DTA. Accordingly, South Africa will not have to forgo tax in accordance with the DTA on income derived by residents of Norfolk Island from sources in South Africa (which will not be subject to Australian tax). [Paragraph 1]

Dual residents

1.20       The article also includes a set of tie-breaker rules for determining how residency is to be allocated to one or other of the countries for the purposes of the DTA if a taxpayer - whether an individual, a company or other entity - qualifies as a dual resident, i.e. as a resident under the domestic law of both countries.

1.21       The tie-breaker rules for individuals apply certain tests, in a descending hierarchy, for determining the residential status (for the purposes of the DTA) of an individual who is a resident of both countries under their respective domestic laws.

1.22       These rules, in order of application are:

·          if the individual has a permanent home in only one of the countries, the person is deemed to be a resident only of that country for the purposes of the DTA;

·          if the individual has a permanent home available in both countries or in neither, then their residential status takes into account the person’s personal or economic relations (including the person’s habitual abode) with Australia and South Africa, and the person is deemed to be a resident only of the country for the purposes of the DTA with which they have the closer personal and economic relations.

[Paragraph 2]

1.23       Dual residents remain, however, in relation to each country, a resident for the purposes of their domestic law and subject to its tax as such insofar as the DTA allows.

1.24       In circumstances where the dual resident is a company the DTA provides that, for the purposes of the DTA, the company will be deemed to be a resident for the purposes of the DTA only of the country in which its place of effective management is situated. [Paragraph 3]

Article 5 - Permanent establishment

Role and definition

1.25       Application of various provisions of the DTA (principally Article 7 relating to business profits) is dependent upon whether a person who is a resident of one country has a ‘permanent establishment’ in the other, and if so, whether income derived by the person in the other country is attributable or effectively connected with carrying on a business through that ‘permanent establishment’. The definition of the term ‘permanent establishment’ which this article embodies, corresponds generally with definitions of the term in Australia’s more recent DTAs.

Meaning of permanent establishment

1.26       The primary meaning of the term permanent establishment is expressed as being a fixed place of business through which the business of an enterprise is wholly or partly carried on. A ‘permanent establishment’ must comply with the following requirements:

·          there must be a place of business;

·          the place of business must be fixed (both in terms of physical location and in terms of time);

·          the business of the enterprise must be carried on through this fixed place.

[Paragraph 1]

1.27       Other paragraphs of the article elaborate on the meaning of the term by giving examples (by no means intended to be exhaustive) of what may constitute a ‘permanent establishment’ - for example:

·          an office;

·          a workshop; or

·          a mine.

As paragraph 2 is subordinate to paragraph 1, the examples listed will only constitute a ‘permanent establishment’ if the primary definition in paragraph 1 is satisfied. [Paragraph 2]

Agricultural, pastoral or forestry activities

1.28       All of Australia’s comprehensive DTAs include as a ‘permanent establishment’ an agricultural, pastoral or forestry property . This reflects Australia’s policy of retaining taxing rights over exploitation of Australian land for the purposes of primary production. This approach ensures that the arms length profits test provided for in Article 7 ( Business profits ) apply to the determination of profits derived from these activities. This position is also reflected in this DTA. [Sub-paragraph 2(g)]

Building sites or construction, installation or assembly projects

1.29       Also consistent with Australia’s DTA practice, sub-paragraph 2(h) of the DTA includes building sites or construction, installation or assembly projects which exist for more than 12 months as examples of a ‘permanent establishment’. Building sites, construction, installation and assembly projects lasting less than 12 months, which nevertheless meet the requirements of other ‘permanent establishment’ rules will be ‘permanent establishments’.

1.30       The term ‘building site or a construction, installation or assembly project’ covers constructional activities such as excavating or dredging. The term ‘building site’ can only mean such work as is directly connected with the erection of buildings and similar projects (earth work, masonry, painting, roofing, glazing and plumbing). Planning and supervision are certainly part of the building site if carried out by the construction contractor. However, planning and supervision of work does not represent a building site if carried out by another enterprise (see paragraph 1.35 regarding sub-paragraph 4(a) of Article 5).

Preparatory and auxiliary activities

1.31       Certain activities are deemed not to give rise to a permanent establishment, for example use of facilities or maintenance of a stock of goods solely for storage, display or irregular delivery, or preparatory or auxiliary activities.

1.32       Generally these activities are of a preparatory or auxiliary character and are unlikely to give rise to substantial profits. The necessary economic link between the activities of the enterprise and the country in which the activities are carried on does not exist in these circumstances.

1.33       Unlike the OECD Model Tax Convention on Capital and Income (the OECD Model), which provides that the listed activities are deemed not to constitute a ‘permanent establishment’, the DTA incorporates the Australian DTA approach of stating that an enterprise will not be deemed to have a ‘permanent establishment’ merely by reason of such activities. This is to prevent the situation where enterprises structure their business so that most their activities fall within the exceptions when - viewed as a whole - the activities ought to be regarded as a ‘permanent establishment’.

1.34       Another feature consistent with Australia’s DTA practice is that sub-paragraph 4(f) of the OECD Model - dealing with combinations of the activities in sub-paragraphs (a) to (e) - is not included. Australia does not consider that an enterprise undertaking multiple functions of the kind indicated in sub-paragraphs (a) to (e) could reasonably be regarded as only engaged in preparatory or auxiliary activities. [Paragraph 3]

Deemed permanent establishments

Supervisory activities

1.35       Supervisory activities carried on for more than 12 months in connection with a building site or a construction, installation or assembly project are deemed to constitute a permanent establishment. Australia has a reservation on Article 5 of the OECD Model reflecting this position. The rationale for inclusion of this provision is the prevalence of the use in Australia of imported expertise in relation to supervision of such projects. [Sub-paragraph 4(a)]

Substantial equipment

1.36       Under sub-paragraph 4(b) an enterprise is deemed to have a ‘permanent establishment’ in a State if substantial equipment is being used in that State by, for or under contract with the enterprise.

1.37       This position is reflected in Australia’s reservation to the OECD Model and one effect is to further protect Australia’s right to tax income from natural resources. Australia’s experience is that the ‘permanent establishment’ provision in the OECD Model may be inadequate to deal with high value activities involved in the development of natural resources, particularly in offshore regions.

1.38       Some examples of substantial equipment would include:

·          large industrial earth moving equipment or construction equipment used in road building, dam building or powerhouse construction etc.;

·          manufacturing or processing equipment used in a factory;

·          oil and drilling rigs, platforms and other structures used in the petroleum/mining industry; and

·          grain harvesters and other large agricultural machinery.

1.39       For the purposes of the application of Article 7.1 the enterprise is deemed to carry on business through the substantial equipment permanent establishment. [Sub-paragraph 4(b)]

Cost-toll operations

1.40       The inclusion of sub-paragraph 4(c) is consistent with another of Australia’s reservations to the OECD Model. It deals with so-called cost-toll situations, under which a mineral plant refines minerals at cost, so that the plant operations produce no Australian profits. Title to the refined product remains with the mining consortium and profits on sale are realised mainly outside of Australia.

1.41       Sub-paragraph 4(c) deems such a plant to be a ‘permanent establishment’ because the manufacturing or processing activity (which gives the processed minerals their real value) is conducted in Australia, and therefore Australia should have taxing rights over business profits arising from the sale of the processed minerals to the extent that they are attributable to the processing activity carried on in Australia. This sub-paragraph prevents an enterprise which carries on very substantial manufacturing or processing activities in a country through an intermediary from claiming that it does not have a permanent establishment in that country.

1.42       The inclusion of this sub-paragraph is insisted upon by Australia in its DTAs and is consistent with Australia’s policy of retaining taxing rights over exploitation of its mineral resources. [Sub-paragraph 4(c) ]

Dependent agents

1.43       Paragraph 5 reflects Australia’s DTA practice in relation to a person who acts on behalf of an enterprise of another country of deeming that person to constitute a ‘permanent establishment’ if that person has and habitually exercises an authority to conclude contracts on behalf of the enterprise. This will apply unless the agent’s activities are limited to the purchase of goods or merchandise for the enterprise, or the agent is an ‘independent agent’ to whom paragraph 6 applies.

Independent agents

1.44       Business carried on through an independent agent does not, of itself, constitute a ‘permanent establishment’, provided that the independent agent is acting in the ordinary course of that agent’s business as such an agent. [Paragraph 6]

Subsidiary companies

1.45       Generally a subsidiary company will not be a ‘permanent establishment’ of its parent company. A subsidiary, being a separate legal entity, would not usually be carrying on the business of the parent company but rather its own business activities. However a subsidiary company gives rise to a ‘permanent establishment’ if the subsidiary permits the parent company to operate from its premises such that the tests in paragraph 1 are met, or acts as an agent such that a dependent agent ‘permanent establishment’ is constituted. [Paragraph 7]

Other articles

1.46       The principles set down in this article are also to be applied in determining whether a permanent establishment exists in a third country or whether a third country has a permanent establishment in Australia (or in South Africa) when applying the source rule contained in:

·          paragraph 5 of Article 11 ( Interest ); and

·          paragraph 5 of Article 12 ( Royalties ).

 [Paragraph 8]

Article 6 - Income from real (immovable) property

Where income from real property is taxable

1.47       This article provides that the income of a resident of one country from real property situated in the other country may be taxed by the other country. Thus income from real property in Australia will be subject to Australian tax laws. [Paragraph 1]

Definition

1.48       Income from real property is effectively defined as extending, in the case of Australia , to:

·          the direct use, letting or use in any other form of real property, a lease of land and any other interest in or over land (including exploration and mining rights); and

·          royalties and other payments relating to the exploration for or exploitation of mines or quarries or other natural resources or rights in relation thereto.

1.49       In the case of South Africa , real property is generally defined as immovable property and includes:

·          property accessory to immovable property;

·          rights to which the general law in respect of landed property apply;

·          usufruct of immovable property; and

·          rights to variable or fixed payments as consideration for the exploitation of or the right to explore for or exploit, or in respect of exploitation of, mineral, oil or gas deposits, and other natural resources.

[Paragraphs 2 and 4]

Deemed situs

1.50       Under Australian law the situation of an interest in land, such as a lease, is not necessarily where the underlying property is situated - there may not necessarily be a situs. Paragraph 3 puts the situation of the interest or right beyond doubt. [Paragraph 3]

Real property of an enterprise and of persons performing independent personal services

1.51       The operation of this article extends to income derived from the use or exploitation of real property of an enterprise and income derived from real property that is used for the performance of independent personal services.

1.52       Accordingly, application of this article (when read with Articles 7 and 14) to such income ensures that the country in which the real property is situated may impose tax on the income derived from that property by:

·          an enterprise of the other country; or

·          an independent professional person resident in that other country;

irrespective of whether or not that income is attributable to a ‘permanent establishment’ of such an enterprise, or ‘fixed base’ of such a person, situated in the firstmentioned country. [Paragraph 5]

Article 7 - Business profits

1.53       This article is concerned with the taxation of business profits derived by an enterprise that is a resident of one country from sources in the other country.

1.54       The taxing of these profits depends on whether they are attributable to the carrying on of a business through a ‘permanent establishment’ in the other country. If a resident of one country carries on business through a ‘permanent establishment’ (as defined in Article 5) in the other country, the country in which the ‘permanent establishment’ is situated may tax the profits of the enterprise that are attributable to that permanent establishment.

1.55       If a taxpayer who is a resident of one country carries on business through an enterprise that does not have a ‘permanent establishment’ in the other country, the general principle of the article is that the taxpayer will not be liable to tax in the other country on the business profits of that enterprise (but see the explanation at paragraphs 1.59 and 1.60 concerning paragraph 6 of the article). [Paragraph 1]

Determination of business profits

1.56       Profits of a ‘permanent establishment’ are to be determined for the purposes of the article on the basis of arm’s length dealing. The provisions in the DTA correspond to international practice and the comparable provisions in Australia’s other DTAs. [Paragraphs 2 and 3]

1.57       No profits are to be attributed to a ‘permanent establishment’ merely because it purchases goods or merchandise for the enterprise. Accordingly, profits of a permanent establishment derived from business activities carried on in its own right will not be increased by adding to them any profits attributable to the purchasing activities undertaken for the head office. It follows, of course, that any expenses incurred by the permanent establishment in respect of those purchasing activities will not be deductible in determining the taxable profits of the permanent establishment. [Paragraph 4]

Inadequate information

1.58       This article allows for the application of the domestic law of the country in which the profits are sourced (e.g. Australia’s Division 13 of the ITAA 1936) where, due to inadequate information, the correct amount of profits attributable on the arm’s length principle basis to a ‘permanent establishment’ cannot be determined or can only be ascertained with extreme difficulty. [Paragraph 5]

Income or gains dealt with under other articles

1.59       Where income or gains are otherwise specifically dealt with under other articles of the Agreement the effect of those particular articles is not overridden by this article.

1.60       This provision lays down the general rule of interpretation that categories of income or gains which are the subject of other articles of the DTA (e.g. shipping, dividends, interest, royalties and alienation of property) are to be treated in accordance with the terms of those articles and as outside the scope of this article (except where otherwise provided - e.g. by Article 10.5 where the income is effectively connected to a permanent establishment). [Paragraph 6]

Insurance with nonresidents

1.61       Each country has the right to continue to apply any special provisions in its domestic law relating to the taxation of income from insurance. However, if the relevant law in force in either country at the date of signature of the DTA is varied (otherwise than in minor respects so as not to affect its general character), the countries must consult with each other with a view to agreeing to any amendment of this paragraph that may be appropriate. An effect of this paragraph is to preserve, in the case of Australia, the application of Division 15 of Part III of the ITAA 1936 (Insurance with Non-residents). [Paragraph 7]

Trust beneficiaries

1.62       The principles of this article will apply to business profits derived by a resident of one of the States (directly or through one or more interposed trust estates) as a beneficiary of a trust estate. Due to differences in the domestic law definitions, in the case of South Africa the DTA defines ‘trust estate’ to mean a ‘trust’. [Paragraph 8]

Example 1.1

In accordance with this article, Australia has the right to tax a share of business profits, originally derived by a trustee of a trust estate (other than a trust estate that is treated as a company for tax purposes) from the carrying on of a business through a permanent establishment in Australia, to which a resident of South Africa is beneficially entitled under the trust estate. Paragraph 8 ensures that such business profits will be subject to tax in Australia where, in accordance with the principles set out in Article 5, the trustee of the relevant trust estate has a permanent establishment in Australia in relation to that business.

Article 8 - Ships and aircraft

1.63       The main effect of this article is that the right to tax profits from the operation of ships or aircraft in international traffic, including profits derived from participation in a pool service or other profit sharing arrangement, is generally reserved to the country in which the operator is a resident for tax purposes. [Paragraph 1]

Non transport operations

1.64       However, the article reflects Australian treaty policy to reserve to the other country the right to tax profits from internal traffic, profits from other coastal and continental shelf activities including non transport shipping and aircraft activities within its own waters.

1.65       Thus, the term transport is not used in the title of the article, as the article applies to survey ships, oil drilling ships etc. where transport is not necessarily involved. [Paragraph 2]

1.66       Paragraph 3 extends the application of the article to profits derived from the lease of ships or aircraft on a bareboat basis, or of containers and related equipment, where the lease of such ships or aircraft, or the containers and related equipment, is incidental to the international operation of the ships or aircraft. The article only extends to such profits, however, where the lessee operates the ships or aircraft in international traffic or the containers and related equipment are so used. [Paragraph 3]

1.67       By reason of the definition of ‘Contracting State’ contained in Article 3 and the terms of paragraph 4 of this article, any shipments by sea or air from a place in Australia (including the continental shelf areas and external territories) for discharge at another place in or for return to that place in Australia, is to be treated as forming part of internal traffic. [Paragraph 4]

Example 1.2

Profits derived from a shipment of goods taken on board (during the course of an international voyage between a place in South Africa and Sydney) at Perth for delivery to Melbourne, would be profits from internal traffic. As such, 5% of the amount paid in respect of the internal traffic carriage would be deemed to be taxable income of the operator for Australian tax purposes pursuant to Division 12 of Part III of the ITAA 1936.

Article 9 - Associated enterprises

Re-allocation of profits

1.68       This article deals with associated enterprises (parent and subsidiary companies and companies under common control). It authorises the re-allocation of profits between related enterprises in Australia and South Africa on an arm’s length basis where the commercial or financial arrangements between the enterprises differ from those that might be expected to operate between independent enterprises dealing wholly at arm’s length with one another.

1.69       The article would not generally authorise the rewriting of accounts of associated enterprises where it can be satisfactorily demonstrated that the transactions between such enterprises have taken place on normal, open market commercial terms. [Paragraph 1]

1.70       Each country retains the right to apply its domestic law relating to the determination of the tax liability of a person (e.g. Australia’s Division 13 of the ITAA 1936) to its own enterprises, provided that such provisions are applied, so far as it is practicable to do so, consistently with the principles of the article. [Paragraph 2]

1.71       Australia’s domestic law provisions relating to international profit shifting arrangements were revised in 1981 in order to deal more comprehensively with arrangements under which profits are shifted out of Australia, whether by transfer pricing or other means. The broad scheme of the revised provisions is to impose arm’s length standards in relation to international dealings, but where the Commissioner of Taxation (the Commissioner) cannot ascertain the arm’s length consideration, it is deemed to be such amount as the Commissioner determines. Paragraph 2 is designed to preserve the application of those domestic law provisions.

Correlative adjustments

1.72       Where a re-allocation of profits is made (either under this article or, by virtue of paragraph 2, under domestic law) so that the profits of an enterprise of one country are adjusted upwards, a form of double taxation would arise if the profits so re-allocated continued to be subject to tax in the hands of an associated enterprise in the other country. To avoid this result, the other country is required to make an appropriate compensatory adjustment to the amount of tax charged on the profits involved to relieve any such double taxation.

1.73       It would generally be necessary for the affected enterprise to apply to the competent authority of the country not initiating the re-allocation of profits for an appropriate compensatory adjustment to reflect the re-allocation of profits made by the other treaty partner country. If necessary, the competent authorities of Australia and South Africa will consult with each other to determine the appropriate adjustment. [Paragraph 3]

Article 10 - Dividends

1.74       This article broadly allows both countries to tax dividends flowing between them but in general limits the rate of tax that the country of source may impose on dividends payable by companies that are residents of that country under its domestic law to beneficial owners resident in the other country. [Paragraph 1]

Rate of tax

1.75       Under this article, Australia will reduce its rate of withholding tax on unfranked dividends paid by Australian resident companies to residents of South Africa to 15% of the gross amount of the dividends. But for this provision, the normal domestic law rate of 30% would have applied.

1.76       The DTA provides that Australia will not tax franked dividends flowing to South African parent companies (with a voting power interest of at least 10% in the subsidiary). Reciprocally, South Africa will not tax dividends fully taxed at the corporate level.

1.77       In other cases the DTA provides that South Africa will generally limit its tax to 15% of the dividend.

1.78       The proviso allows some flexibility if there is a change to either country’s general approach to dividend withholding taxes, such as a change to domestic law arrangements for franked dividends flowing overseas. In such a case the 2 countries are obliged to consult on the matter. [Paragraphs 2 and 3]

Exception to limitation

1.79       The limitation on the tax of the country in which the dividend is sourced does not apply to dividends derived by a resident of the other country who has a ‘permanent establishment’ or ‘fixed base’ in the country from which the dividends are derived, if the holding giving rise to the dividends is effectively connected with that ‘permanent establishment’ or ‘fixed base’.

1.80       Where the dividends are so effectively connected, they are to be treated as ‘business profits’ or ‘income from independent personal services’ and therefore subject to the source country’s tax (in accordance with the provisions of Article 7 or Article 14, as the case may be). In practice, however, under changes made to Australia’s domestic law with the introduction from 1 July 1987 of a full imputation system of company taxation, such dividends to the extent that they are franked dividends will remain exempt from Australian tax, while unfranked dividends will be subject to withholding tax at the rate of 15% instead of being taxed by assessment. [Paragraph 5]

Extra-territorial application

1.81       The extra-territorial application by either country of taxing rights over dividend income is precluded by providing, broadly, that one country (the first country) will not tax dividends paid by a company resident solely in the other country, unless:

·          the person deriving the dividends is a resident of the first country; or

·          the holding giving rise to the dividends is effectively connected with a ‘permanent establishment’ or ‘fixed base’ in the first country; or

·          the first country does not impose a branch profits tax in excess of the rate of company income tax (in the case of Australia) or normal company tax (in the case of South Africa) and the dividends are paid out of profits attributable to one or more permanent establishments which the company has in that first country. Where only this third exception applies, any tax so imposed is limited to a maximum of 5% of the gross amount of dividends. This third exception is designed to effectively mirror the 5% limitation imposed by Article 10.7 on a country’s branch profits tax (see paragraphs 1.84 and 1.85).

1.82       Currently, the third exception only applies to Australia (as South Africa imposes a branch profits tax at a rate exceeding the normal company tax rate) and in practice, it will operate to limit the rate of tax imposed under paragraph 44(1)(b) of the ITAA 1936.

1.83       However, the exemption is specified as not applying where the dividend paying company is a dual resident. This proviso ensures that Australia retains the right to tax dividends paid to a person resident outside of both countries by a company which is a resident of Australia under its domestic law notwithstanding that the company is deemed to be a resident of South Africa for the purposes of the agreement pursuant to the dual resident tie-breaker test for companies contained in Article 4. [Paragraph 6]

Branch profits tax

1.84       Paragraph 7 recognises each country’s right to impose a branch profits tax on the profits of permanent establishments in their country but limits the rate of tax to a rate not exceeding more than 5 percentage points of each country’s company tax rate.

1.85       As Australia does not currently impose a branch profits tax, the paragraph is presently only applicable to South Africa. There will be no immediate effect for South Africa whilst its normal company tax rate remains at 35% and its branch profits tax rate is 40%. The paragraph operates to ensure that the branch profits tax will continue to only exceed the company tax rate by a maximum of 5%. [Paragraph 7]

Article 11 - Interest

Rate of tax

1.86       This article provides for interest income to be taxed by both countries but requires the country of source to generally limit its tax to 10% of the gross amount of the interest where a resident of the other country is the beneficial owner of the interest. [Paragraphs 1 and 2]

1.87       The limitation of the source country tax rate to 10% accords with the general rate of interest withholding tax applicable under Australia’s domestic law.

Definition of interest

1.88       The term interest is defined for the purposes of the article in a way that, in relation to Australia, encompasses items of income such as discounts on securities and payments under certain hire purchase agreements which are treated for Australian tax purposes as interest or amounts in the nature of interest. [Paragraph 3]

Interest effectively treated as business profits

1.89       Interest derived by a resident of one country which is effectively connected to a ‘permanent establishment’ or ‘fixed base’ of that person in the other country, will form part of the business profits of that ‘permanent establishment’ or ‘fixed base’ and be subject to the provisions of Article 7 (Business profits) or Article 14 (Independent personal services). Accordingly, the 10% tax rate limitation does not apply to such interest in the country in which the interest is sourced. [Paragraph 4]

Deemed source rules

1.90       Interest source rules are set out in the article. Those rules operate to allow Australia to tax interest to which a resident of South Africa is beneficially entitled where the interest is paid by a resident of Australia. Australia may also tax interest paid by a resident of South Africa to which another South African resident is beneficially entitled if it is an expense incurred by the payer of the interest in carrying on a business in Australia through a ‘permanent establishment’. However, consistent with Australia’s interest withholding tax provisions, an Australian source is not deemed in respect of interest that is an expense incurred by an Australian resident in carrying on a business through a ‘permanent establishment’ outside Australia. [Paragraph 5]

Related persons

1.91       This article also contains a general safeguard against payments of excessive interest - in cases where there is a special relationship between the persons associated with a loan transaction - by restricting the 10% tax rate limitation in the country in which the interest is sourced to the amount of the interest which it might be expected would have been agreed upon if the parties to the loan agreement were dealing with one another at arm’s length. Any excess part of the interest remains taxable according to the domestic law of each country but subject to the other articles of this DTA. [Paragraph 6]

Article 12 - Royalties

Rate of tax

1.92       The article in general allows both countries to tax royalty flows but limits the tax of the country of source to 10% of the gross amount of royalties paid or credited to residents of the other country beneficially entitled to the royalties. [Paragraphs 1 and 2]

1.93       The 10% rate limitation is not to apply to natural resource royalties, which, in accordance with Article 6, are to remain taxable in the country of source without limitation of the tax that may be imposed.

1.94       In the absence of a DTA, Australia’s taxes royalties paid to nonresidents at 30% of the gross royalty.

Definition of royalties

1.95       The definition of royalties in the DTA reflects the definition in Australia’s domestic income tax law. The definition encompasses payments for the use of, or the right to use industrial, commercial or scientific equipment. It also includes payments for the supply of scientific, technical, industrial or commercial know-how but not payments for services rendered. Payments made for the right to copy or adapt computer software in a manner which would, without the permission of the copyright owner, constitute an infringement of copyright, also constitute royalty payments. [Paragraph 3]

Payments for the supply of know-how versus payments for services rendered

1.96       It is considered that a German Supreme Court decision (Bundesfinanzhof (No. IR 44/67) of 16 December 1970) provides a definitive test to distinguish between a know-how contract and a contract for services. A know-how contract, it was held, involved the supply by a person of his or her know-how to the paying entity (e.g. teaching a personal expertise), whereas in a contract for services, although it may involve the use of know-how, that know-how is applied by the person in the performance of his or her services.

1.97       Payments for design, engineering or construction of plant or building, feasibility studies, component design and engineering services may generally be regarded as being in respect of a contract for services, unless there is some provision in the contract for imparting techniques and skills to the buyer .

1.98       In cases where both know-how and services are supplied under the same contract, if the contract does not separately provide for payments in respect of know-how and services, an apportionment of the 2 elements of the contract may be possible.

1.99       Payments for services rendered are to be treated under Article 7 ( Business profits ) or Article 15 ( Independent personal services ).

Forbearance

1.100     Consistently with Australian tax treaty practice, sub-paragraph (h) expressly treats as a royalty, amounts paid or credited in respect of forbearance to grant to third persons, rights to use property covered by the royalty article. This is designed to prevent arrangements along the lines of those contained in Aktiebolaget Volvo v. Federal Commissioner of Taxation (1978) 8 ATR 747; 78 ATC 4316, where instead of amounts being payable for the exclusive right to use the property they were made for the undertaking that the right to use the property will not be granted to anyone else, not being subject to tax as a royalty payment under the terms of Article 12. [Sub-paragraph 3(h)]

Other royalties effectively treated as business profits

1.101     As in the case of interest income, it is specified that the 10% tax rate limitation is not to apply to royalties effectively connected with a ‘permanent establishment’ or ‘fixed base’ in the country in which the income is sourced - such income being subject to full taxation under either Article 7 or Article 14 as the case may be. [Paragraph 4]

Deemed source rule

1.102     The royalties source rule provided for in the DTA effectively corresponds in the case of Australia with the deemed source rule contained in section 6C (Source of royalty income derived by a nonresident) of the ITAA 1936 for royalties paid to nonresidents of Australia. It broadly mirrors the source rule for interest income contained in paragraph 5 of Article 11 (Interest). [Paragraph 5]

Related persons

1.103     If royalties flow between the payer and the person beneficially entitled to the royalties as the result of a special relationship between them, the 10% source country tax rate limitation will apply only to the extent that the royalties are not excessive. Any excess part of the royalty remains taxable according to the domestic law of each country but subject to the other articles of this DTA.

1.104     A special relationship is generally taken to exist where royalties are paid to an individual by an associate or legal person who is directly or indirectly controlled by an individual or associated legal person or to a subordinate, or a group having a common interest with them. It covers those relationships that exist by way of blood or marriage and in general any community of interest. [Paragraph 6]

Article 13 - Alienation of property

Taxing rights

1.105     This article allocates between the respective countries taxing rights in relation to income, profits or gains arising from the alienation of real (immovable) property (as defined in Article 6) and other items of property.

1.106     Income, profits or gains from the alienation of real property may be taxed by the country in which the property is situated. [Paragraph 1]

Permanent establishment

1.107     Paragraph 2 deals with income, profits or gains arising from the alienation of property (other than real property covered by paragraph 1) forming part of the business assets of a permanent establishment of an enterprise or pertaining to a fixed base used for performing independent personal services. It also applies where the permanent establishment itself (alone or with the whole enterprise) or the fixed base is alienated. Such income or gains may be taxed in the country in which the permanent establishment or fixed base is situated. This corresponds to the rules for business profits and for income from independent personal services contained in Articles 7 and 14 respectively. [Paragraph 2]

Disposal of ships or aircraft

1.108     Income, profits or gains from the disposal of ships or aircraft operated in international traffic, or associated property (other than real property covered by paragraph 1) are taxable only in the country of resident of the operator of the ships or aircraft. This rule corresponds to the operation of Article 8 in relation to profits from the operation of ships or aircraft in international traffic.

Shares and other interests in land-rich entities

1.109     Paragraph 4 extends the coverage of this article to situations involving the alienation of shares or other interests in companies, and other entities, whose assets consist principally of real property (as defined in Article 6) which is situated in the other country (again, in the terms of Article 6). Such income or gains may thus be taxed by the country in which the real property is situated. This paragraph complements paragraph 1 of this article and is designed to cover arrangements involving the effective alienation of incorporated real property, or like arrangements.

1.110     This is to be the case whether the real property is held directly or indirectly through a chain of interposed entities. While not limited to chains of companies, or even chains of entities only some of which are companies, the example of chains of companies is used to make clear that the corporate veil should be lifted in examining direct or indirect ownership.

1.111     This provision responds to the tax planning opportunities exposed by the decision of the Full Federal Court in the Commissioner of Taxation v. Lamesa Holdings BV (1997) 77 FCR 597. It is designed to protect Australian taxing rights over income, profits or gains on the alienation or effective alienation of Australian real property (as defined) despite the presence of interposed bodies corporate or other entities. The South African DTA is the first new DTA to include such revised provisions. [Paragraph 4]

Capital gains

1.112     The article contains a sweep-up provision in relation to capital gains which enables each country to tax, according to its domestic law, any gains of a capital nature derived by its own residents or by a resident of the other country from the alienation of any property not specified in the preceding paragraphs of the article. It thus preserves the application of Australia’s domestic law relating to the taxation of capital gains in relation to the alienation of such property. [Paragraph 5]

Definition of real property

1.113     The term real property is to be defined for the purposes of this article as it is under Article 6. Where the property is situated is determined in accordance with paragraph 3 of Article 6. [Paragraphs 6 and 7]

Business profits

1.114     As indicated earlier, income, profits or gains from the alienation of property that fall within the scope of this article are not affected by the ‘business profits’ provisions of Article 7. In the event that the operation of this article should result in an item of income or gain being subjected to tax in both countries, the country in which the person deriving the income or gain is a resident (as determined in accordance with Article 4) would be obliged by Article 22 ( Source of income ) and Article 23 ( Methods of elimination of double taxation ) to provide double tax relief for the tax imposed by the other country.

Article 14 - Independent personal services

Taxing rights

1.115     Under this article income derived by an individual in respect of professional services or other independent activities will be subject to tax in the country in which the services or activities are performed if either:

·          the recipient has a fixed base regularly available in that other country for the purposes of performing his or her activities; or

·          the individual is present in that country for a period or periods exceeding in the aggregate 183 days in any 12 month period commencing or ending in a year of income or year of assessment of the visited country.

1.116     If either of these conditions is met, the country in which the services or activities are performed will be able to tax so much of the income as is attributable to the activities performed during such period or periods or that are exercised from that fixed base. [Paragraph 1]

1.117     If the above tests are not met, the income will be taxed only in the country of residence of the recipient.

1.118     Remuneration derived as an employee and income derived by public entertainers are the subjects of other articles of the DTA and are not covered by this article.

Article 15 - Dependent personal services

Basis of taxation

1.119     This article generally provides the basis upon which the remuneration of visiting employees is to be taxed. The provisions of this article do not apply, however, in respect of income that is dealt with separately in:

·          Article 16 ( Directors’ fees );

·          Article 18 ( Pensions and annuities ); and

·          Article 19 ( Government service );

of the DTA.

1.120     Generally, salaries, wages and similar remuneration derived by a resident of one country from an employment exercised in the other country will be liable to tax in that other country. However, subject to specified conditions, there is a conventional provision for exemption from tax in the country being visited where visits of only a short-term nature are involved. [Paragraph 1]

Exemption

1.121     The conditions for this exemption are that:

·          the visit or visits do not exceed, in the aggregate, 183 days in any 12 month period commencing or ending in the year of income or year of assessment concerned of the visited country;

·          the remuneration is paid by, or on behalf of, an employer who is not a resident of the country being visited; and

·          the remuneration is not deductible in determining taxable profits of a ‘permanent establishment’ or a ‘fixed base’ which the employer has in the country being visited.

1.122     Where all of these conditions are met, the remuneration so derived will be liable to tax only in the country of residence of the recipient. [Paragraph 2]

Short-term visit

1.123     Where a short-term visit exemption is not applicable, remuneration derived by a resident of Australia from employment in South Africa may be taxable in South Africa. However, the article does not allocate sole taxing rights to South Africa in that situation.

1.124     Accordingly, Australia would also be entitled to tax that remuneration in accordance with the general rule of the Income Tax Assessment Act 1997 that a resident of Australia remains subject to tax on worldwide income. In common, however, with other situations where the DTA allows both countries to tax a category of income, Australia would be required in this situation (pursuant to Article 23), as the country in which the income recipient is resident for tax purposes, to relieve the double taxation that would otherwise occur.

1.125     Although that article provides for the double tax relief to be provided by Australia to be in the form of the grant of a credit against the Australian tax for the South African tax paid, the exemption with progression method of providing double tax relief in relation to employment income derived in the situation described would normally be applicable in practice pursuant to the foreign service income provisions of section 23AG of the ITAA 1936. This method takes into account the foreign earnings when calculating the Australian tax on other assessable income the person has derived.

Employment on a ship or aircraft

1.126     Income from an employment exercised aboard a ship or aircraft operated in international traffic may be taxed in the country of residence of the operator. [Paragraph 3]

Article 16 - Directors’ fees

1.127     Under this article, remuneration derived by a resident of one country in the capacity of a director of a company which is a resident of the other country may be taxed in the latter country.

Article 17 - Entertainers and sportspersons

Personal activities

1.128     By this article, income derived by visiting entertainers and sportspersons from their personal activities as such may generally be taxed in the country in which the activities are exercised, irrespective of the duration of the visit. The words ‘income derived by entertainers...from their personal activities as such...’ extend the application of this article to income generated from promotional and associated kinds of activities engaged in by the entertainer or sportsperson while present in the visited country. [Paragraph 1]

Safeguard

1.129     There is a safeguard provision included in this article which is designed to ensure that income in respect of personal activities exercised by an entertainer or sportsperson, whether received:

·          by the entertainer or sportsperson; or

·          by another person, for example, a separate enterprise which formally provides the entertainer’s or sportsperson’s services;

is taxed in the country in which the entertainer or sportsperson performs, whether or not that other person has a ‘permanent establishment’ or ‘fixed base’ in that country. [Paragraph 2]

Article 18 - Pensions and annuities

1.130     Pensions and annuities (excluding government service pensions dealt with under Article 19.2) are to be taxed only in the country of residence of the recipient provided that such pensions and annuities are included in taxable income in that country. [Paragraph 1]

Scope of article

1.131     Australia has a reservation to the OECD Model which states that Australia will propose in negotiations that all pensions be taxable only in the country of residence of the recipient. However, as pursuant to its territorial system of taxation, South Africa only taxes South African sourced pensions under its domestic law. Australia’s usual approach would have resulted in Australian pensions paid to South African residents not being taxed in either country.

1.132     The wording of this article therefore ensures that the country of residence generally has sole taxing rights over such pensions, but also ensures that where the country of residence does not include such pensions and annuities in taxable income (as is the case for Australian pensions paid to South African residents), the DTA does not prevent the source (paying) country from taxing such pensions and annuities. Australia can therefore continue to exercise its source country taxing rights over Australian pensions paid to South African residents until such time as South Africa changes its domestic law to generally include foreign pension payments in taxable income.

Annuities purchased by way of a lump sum payment

1.133     An annuity paid to a former resident of either country which was purchased by way of a lump sum payment from an insurer in that country may be taxed by both countries, with the country of residence of the recipient providing double tax relief. This accords with South African domestic law and is designed to avoid the situation where South African residents can, by purchasing an annuity, effectively avoid South African limitations on the export of South African capital and escape the South African tax net on the resulting income. Under the DTA, Australia is also able to tax relevant purchased annuities paid to former Australian residents who have migrated to South Africa.

1.134     It is intended that the operation of this article extends to pension and annuity payments made to dependants, for example a widow or children, of the person in respect of whom the pension or annuity entitlement accrued where, upon that person’s death, such entitlement has passed to that person’s dependants.

Article 19 - Government service

Salary and wage income

1.135     Salary and wage type income, other than a pension or annuity, paid to an individual for services rendered to a government (including a State or local authority) of one the countries, is to be taxed only in that country. However, such remuneration is to be taxable only in the other country if:

·          the services are rendered in that other country;

·          the recipient is a resident of that other country for the purposes of that country’s tax; and

·          either the recipient is a citizen or national of that other country or did not become a resident of that other country solely for the purpose of rendering the services.

[Paragraph 1]

Government service pensions

1.136     Pensions paid by, or out of funds created by, one of the countries (or a political subdivision or local authority of that country) for services rendered to that country will be taxable only in that country. [Sub-paragraph 2(a)]

1.137     However, if the recipient is a resident of and a citizen or national of the other country, the pension will be taxable in that other country provided the services in respect of which that pension is paid were rendered in that country. Thus an Australian government service pension paid to a South African resident who is also a South African national will only be taxable in South Africa, if the services which gave rise to that pension were rendered in South Africa. [Sub-paragraph 2(b)]

Trade or business income

1.138     Remuneration or pensions for services rendered in connection with a trade or business carried on by a government or authority referred to in paragraphs 1 or 2 is excluded from the scope of this article. This remuneration will remain subject to the provisions of Article 15 ( Dependent personal services ), Article 16 ( Directors’ fees ), Article 17 ( Entertainers and sportspersons ) and Article 18 ( Pensions and annuities ) as the case may be. [Paragraph 3]

Article 20 - Students

Exemption from tax

1.139     This article applies to students temporarily present in one of the countries solely for the purpose of their education if the students are, or immediately before the visit were, resident in the other country. In these circumstances, the students will be exempt from tax in the country visited for payments received from abroad for their maintenance or education (even though they may qualify as a resident of the country visited during the period of their visit).

1.140     The exemption from tax provided by the visited country is treated as extending to maintenance payments received by the student that are made for maintenance of dependent family members who have accompanied the student to the visited country.

Employment income

1.141     Where however, a student from South Africa who is visiting Australia solely for educational purposes undertakes:

·          some part time work with a local employer; or

·          during a semester break undertakes work with a local employer;

the income earned by that student as a consequence of that employment may, as provided for in Article 15, be subject to tax in Australia. In this situation the payments received from abroad for the student’s maintenance or education will not however be taken into account in determining the tax payable on the employment income that is subject to tax in Australia.

Article 21 - Other income

Allocation of taxing rights

1.142     This article provides rules for the allocation between the 2 countries of taxing rights to items of income not dealt with in the preceding articles of the DTA. The scope of the article is not confined to such items of income arising in one of the countries - it extends also to income from sources in a third country.

1.143     Broadly, such income derived by a resident of one country is to be taxed only in his or her country of residence unless it is derived from sources in the other country, in which case the income may also be taxed in the other country. Where this occurs, the country of residence of the recipient of the income would be obliged by Article 23 ( Methods of elimination of double taxation ) to provide double taxation relief. [Paragraphs 1 and 3]

1.144     This article does not apply to income (other than income from real property as defined in Article 6(2)) where the right or property in respect of which the income is paid is effectively connected with a permanent establishment or ‘fixed base’ which a resident of one country has in the other country. In such a case, Article 7 ( Business profits ) or Article 14 ( Independent personal services ), as the case may be, will apply. [Paragraph 2]

Note

1.145     This article effectively contains sweep-up provisions in relation to items of income not dealt with in other articles of the DTA and paragraph 5 of Article 13 effectively sweeps-up capital gains not dealt with in the other paragraphs of that article.

Article 22 - Source of income

Deemed source

1.146     This article effectively deems income, profits or gains derived by a resident of one country which, under the DTA, may be taxed in the other country to have a source in the latter country for the purposes of the DTA and the domestic income tax law of the respective countries. It therefore avoids any difficulties arising under domestic law source rules in respect of, for example, the exercise by Australia of the taxing rights allocated to Australia by the DTA over income derived by residents of South Africa. [Paragraph 1]

Double taxation relief

1.147     The article is also designed to ensure that where an item of income, profits or gains is taxable in both countries, double taxation relief will be given by the income recipient’s country of residence (pursuant to Article 23) for tax levied by the other country as prescribed under the DTA. In this way, income derived by a resident of Australia, which is taxable by South Africa under the DTA, will be treated as being foreign income for the purposes of the ITAA 1936, including the foreign tax credit provisions of that Act. [Paragraph 2]

Article 23 - Methods of elimination of double taxation

1.148     Double taxation does not arise in respect of income flowing between the 2 countries where the terms of the DTA provide either:

·          for the income to be taxed only in one country; or

·          where the domestic taxation law of one of the countries frees the income from its tax.

Tax credit

1.149     It is necessary, however, to prescribe a method for relieving double taxation for other classes of income which, under the DTA, remain subject to tax in both countries. In accordance with international practice, Australia’s DTAs provide for double tax relief to be provided by the country of residence of the taxpayer by way of a credit basis of relief against its tax for the tax of the country of source of the income. This article also reflects that approach.

Australian method of relief

1.150     Australia’s general foreign tax credit system, together with the terms of this article and of the DTA generally, will form the basis of Australia’s arrangements for relieving a resident of Australia from double taxation on income arising from sources in South Africa. As in the case of Australia’s other DTAs, the source of income rules specified by Article 22 for the purposes of the DTA will also apply for those purposes.

1.151     Accordingly, effect is to be given to the tax credit relief obligation imposed on Australia by paragraphs 1 and 2 of this article by application of the general foreign tax credit provisions (Division 18 of Part III) of the ITAA 1936. This will include the allowance of underlying tax credit relief in respect of dividends paid by South African resident companies that are related to Australian resident companies, including for unlimited tiers of related companies, in accordance with the relevant provisions of the ITAA 1936.

1.152     Notwithstanding the credit basis of relief provided for by paragraphs 1 and 2 of this article, the exemption with progression method of relief will be applicable, as appropriate, in relation to salary and wages and like remuneration derived by a resident of Australia during a continuous period of ‘foreign service’ (as defined in subsection 23AG(7) of the ITAA 1936) in South Africa. Other foreign source income exemptions in Australia’s domestic law will also continue to be applicable in respect of relevant South African source income. [Paragraphs 1 and 2]

South African relief

1.153     South Africa is required to allow its residents a deduction for Australian tax paid where they have derived income, profits or gains which are taxed in Australia and which are also subject to tax in South Africa. The deduction is of an amount equal to the Australian tax paid and is made against the South African tax payable on the income, subject to that deduction not exceeding an amount which bears to the total South African tax payable the same ratio as the income concerned bears to the total income. [Paragraph 3]

Article 24 - Mutual agreement procedure

Consultation

1.154     One of the purposes of this article is to provide for consultation between the ‘competent authorities’ of the 2 countries with a view to reaching a satisfactory solution where a person is able to demonstrate actual or potential imposition of taxation contrary to the provisions of the DTA.

Time limits

1.155     A person wishing to use this procedure must present a case to the competent authority of the country of which the person is a resident within 3 years of the first notification of the action which the taxpayer considers gives rise to taxation not in accordance with the DTA. [Paragraph 1]

1.156     If, on consideration by the competent authorities, a solution is reached, it may be implemented irrespective of any time limits imposed by domestic tax law of the relevant country. [Paragraph 2]

Resolution of difficulties

1.157     The article also authorises consultation between the competent authorities of the 2 countries for the purpose of resolving any difficulties regarding the interpretation or application of the DTA and to give effect to it. [Paragraphs 3 and 4]

General Agreement on Trade in Services resolution process

1.158     Paragraph 3 of Article XXII of the World Trade Organization (WTO) General Agreement on Trade in Services (GATS) provides that a disputed measure that falls within the scope of an ‘international agreement relating to the avoidance of double taxation’ may not be resolved under the dispute resolution mechanisms provided by Articles XXII and XXIII of the GATS.

1.159     If there is a dispute as to whether a measure actually falls within the scope of a tax agreement, however, either country may take the matter to the WTO’s Council on Trade in Services for referral to binding arbitration.

1.160     Where the tax agreement in question was entered into prior to the entry into force of the GATS (1 January 1995), it requires the consent of both countries before the matter can be brought to the Council on Trade in Services. This restriction does not apply to subsequent agreements.

1.161     Article 24.5 of the DTA will require the consent of both Australia and South Africa before a disputed matter may be brought before the Council on Trade in Services, even though it will enter into force after 1 January 1995. This is seen as the most effective way of dealing with such disputes, and avoids difficult issues as to when a disputed issue falls for resolution under the dispute resolution mechanism of the DTA or the GATS.

1.162     The provision is based in all essential respects on an OECD Model Commentary recommendation, and is common in recent international practice. [Paragraph 5]

Article 25 - Exchange of information

Limitations on exchange

1.163     This article authorises and limits the exchange of information by the 2 competent authorities to information necessary for the carrying out of the DTA or for the administration of domestic laws concerning the taxes to which the DTA applies. [Paragraph 1]

1.164     The limitation placed on the kind of information authorised to be exchanged means that information access requests relating to taxes not within the coverage provided by Article 2 ( Taxes covered ), for example sales tax, are not within the scope of the article.

Purpose

1.165     The purposes for which the exchanged information may be used and the persons to whom it may be disclosed are restricted consistently with Australia’s other DTAs. Any information received by a country shall be treated as secret in the same manner as information obtained under the domestic law of that country. [Paragraph 1]

1.166     An exchange of information that would disclose any trade, business, industrial, commercial or professional secret or trade process or which would be contrary to public policy is not permitted by the article. [Paragraph 2]

Article 26 - Members of diplomatic missions and consular posts

1.167     The purpose of this article is to ensure that the provisions of the DTA do not result in members of diplomatic and consular posts receiving less favourable treatment than that to which they are entitled in accordance with international conventions. Such persons are entitled, for example, to certain fiscal privileges under the Diplomatic (Privileges and Immunities) Act 1967 and the Consular (Privileges and Immunities) Act 1972 which reflect Australia’s international diplomatic and consular obligations.

Article 27 - Entry into force

Date of entry into force

1.168     This article provides for the entry into force of the DTA. This will be on the last date on which diplomatic notes are exchanged through the diplomatic channel notifying that the last of the domestic processes to give the DTA the force of law in the respective countries has been completed. In Australia, enactment of the legislation giving the force of law in Australia to the DTA along with tabling the treaty in Parliament are prerequisites to the exchange of diplomatic notes.

Withholding tax

1.169     Once it enters into force, the DTA will have effect in Australia for purposes of withholding taxes in respect of income derived on or after 1 January in the calendar year next following that in which the DTA enters into force.

Other taxes

1.170     In respect of other Australian tax, the DTA will first have effect in Australia in relation to income, profits or gains of the Australian year of income beginning on or after 1 July in the calendar year next following that in which it enters into force.

Note

1.171     Where a taxpayer has adopted an accounting period ending on a date other than 30 June, the accounting period that has been substituted for the year of income beginning on 1 July of the calendar year next following that in which the DTA enters into force will be the relevant year of income for the purposes of the application of ‘other Australian tax’.

Date of effect in South Africa

1.172     In South Africa, the DTA will first have effect, in relation to South African taxes withheld at source, on or after 1 January in the calendar year next following the date on which the DTA enters into force. For other South African tax, the DTA will first have effect in South Africa in respect of years of assessment beginning on or after 1 January next following the date on which the DTA enters into force.

Article 28 - Termination

1.173     By this article the DTA is to continue in effect indefinitely. However, either country may give through the diplomatic channel written notice of termination of the DTA on or before 30 June in any calendar year beginning after the expiration of 5 years from the date of its entry into force.

Cessation in Australia

1.174     In that event, the DTA would cease to be effective in Australia for purposes of withholding tax in respect of income derived on or after 1 January next following that in which the notice of termination is given.

1.175     For other Australian tax, it would cease to be effective in relation to income, profits or gains of any year of income beginning on or after 1 July in the calendar year next following that in which the notice of termination is given.

Cessation in South Africa

1.176     It would correspondingly cease to be effective in South Africa in respect of taxes withheld at source, for amounts paid or credited after the end of the calendar year in which the notice of termination is given; and in relation to other South African tax, the termination would first apply for any year of assessment beginning after the end of the calendar year in which the notice of termination is given.

Protocol to the DTA

1.177     The Protocol deals with 2 matters.

Non-discrimination

1.178     The first matter is in relation to the absence from this DTA, consistent with Australia’s current tax treaty policy, of a Non-discrimination Article. The Protocol provides that if Australia should negotiate a Non-discrimination Article in a subsequent Agreement which is given effect to under the International Tax Agreements Act 1953 , then the parties to this DTA will enter into negotiations with a view to providing in this DTA comparable treatment as is provided for in the subsequent Agreement.

Secondary tax on companies

1.179     The second matter concerns the rate at which South Africa imposes its secondary tax on companies. The Protocol provides that if South Africa should limit the rate at which the secondary tax on companies is imposed in a subsequent Agreement with a third country, then the parties to this DTA will enter into negotiations with a view to providing in this DTA comparable treatment as is provided for in that subsequent Agreement.

 



C hapter

Amending protocol to the agreement with Malaysia

What is the Protocol?

2.1         The Protocol, once in force, will amend the Agreement between the Government of Australia and the Government of Malaysia for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income of 20 August 1980 (1980 Agreement).

Why is the Protocol necessary?

The 1980 Agreement

2.2         The 1980 Agreement is a comprehensive taxation agreement between Australia and Malaysia. So far as Australia is concerned, the main impact of the 1980 Agreement has been on Australian enterprises investing in and trading with Malaysia. It has generally assisted in improving the bilateral framework for investment and trade with Malaysia.

The Protocol and the related exchange of Letters generally

2.3         The 1980 Agreement contains tax sparing provisions (Article 23) which reflect Australia’s undertaking to provide tax sparing for certain business and non-business income tax incentives provided by Malaysia under its investment promotion measures. It provided for the tax sparing provisions to apply for an initial 5 year period (which expired at the end of the 1983-1984 year of income) and for that period to be extended for any further period that may be agreed by the respective Governments in an exchange of Letters for that purpose.

2.4         Tax sparing occurs where the tax forgone by a country in providing certain tax concessions to Australian investors is deemed to have been paid for the purposes of Australia’s foreign tax credit system. In the absence of tax sparing, such concessions may, in some circumstances, be negated by Australia’s foreign tax credit system which ‘tops up’ foreign taxes paid to the level of tax that would be due on an equivalent amount of domestic income.

2.5         In 1986 the Malaysian Government introduced some new tax incentives in its tax incentive legislation. In accordance with the mechanism provided for in the 1980 Agreement, Australia and Malaysia have agreed to exchange Letters that will ensure the tax sparing provisions in the 1980 Agreement reflect the changes made to the Malaysian tax incentive legislation. The Letters will also extend the operation of the tax sparing provisions in the 1980 Agreement for a further 3 income years (i.e. generally from 1 July 1984 to 30 June 1987).

2.6         The exchange of Letters under the 1980 Agreement extending the application to 30 June 1987 of the existing tax sparing provisions of that Agreement, has not yet taken place. Entry into force will be on the date of exchange, which is proposed by the end of 1999.

2.7         Amendments contained in the Protocol will operate to provide new tax sparing arrangements in relation to certain designated development incentives provided by Malaysia for an additional 5 year period (i.e. generally from 1 July 1987 to 30 June 1992).

2.8         The Protocol will also overcome the double taxation currently facing some Australian residents who are in receipt of fees for technical services paid by Malaysian residents with effect from the 1993-1994 income year. It has been agreed that the Business Income or Profits article of the 1980 Agreement should apply to the taxation of fees for the furnishing of services, including consultancy services, so that taxing rights in relation to such income are allocated to the country in which the services are utilised only where the services are furnished in that country and the provider of the services has a ‘fixed presence’ in that country of more than 3 months within any 12 month period. This has been achieved by adding an additional clause to the existing permanent establishment definition of the 1980 Agreement and is of most benefit to those Australian businesses providing services to Malaysian firms direct from Australia.

2.9         In addition, the Protocol updates the 1980 Agreement in a number of respects to bring it into line with Australia’s current law and treaty policies and practices. These updates include:

·          changes to the definitions of Australia , Malaysia , and land ; and

·          the insertion of provisions dealing with business profits derived via trusts, interest derived on the investment of a Government’s official reserves or by a bank performing central banking functions; and

·          the allowance of tax credits for the underlying tax (i.e. the tax paid on the profits out of which dividends are paid) paid in respect of non-portfolio dividends (i.e. where the dividend recipient owns at least 10% of the voting shares in the paying company).

The Protocol also substitutes more extensive provisions dealing with the alienation of property.

Main features of the Protocol

2.10       The Protocol makes a number of amendments to the 1980 Agreement.

2.11       It overcomes the double taxation situation currently facing Australian residents who are in receipt of fees for technical services paid by Malaysian residents. Malaysia has accepted Australia’s position that the Business Income or Profits article of the 1980 Agreement should apply to the taxation of fees for the furnishing of services, including consultancy services, so that taxing rights in relation to such income are allocated to the country in which the services are utilised only where the services are furnished in that country and the provider of the services has a ‘fixed presence’ in that country of more than 3 months within any 12 month period. The Entry into force article of the Protocol provides for this provision to have effect from the 1993-1994 year of income. [Article 2]

2.12       Another feature is the extension of tax sparing relief to income which Malaysia exempts or taxes at a reduced rate under special incentive measures to promote economic development in Malaysia. Relevant provisions of the 1980 Agreement, which provide for such relief by treating as paid for foreign tax credit purposes tax forgone by Malaysia on certain income under specified development incentive provisions of its law, expired at the end of the 1983-1984 year of income. In accordance with the terms of the 1980 Agreement, an exchange of Letters will extend the operation of those provisions until the end of the 1986-1987 year of income, after which amendments contained in the Protocol operate to provide new tax sparing arrangements in relation to certain designated development incentives provided by Malaysia for an additional 5 year period.

2.13       Other amendments to the existing agreement with Malaysia made by the Protocol update it in line with Australia’s current domestic law and tax treaty policies and practices, including:

·          revised definitions of Australia and Malaysia in the General Definitions article [Article 1] ;

·          a revised definition of land in the Income from Land article [Article 3] ;

·          a new paragraph in the Business Income or Profits article which clarifies Australia’s right to tax a share of the business profits derived by a resident of Malaysia as a beneficiary of a trust estate (other than a corporate unit trust) through which a business is carried on in Australia [Article 4] ;

·          a sovereign immunity provision in the Interest article [Article 5] ;

·          a substitute article containing specific taxing rules in relation to income, profits or gains arising from the alienation of real property, certain business assets and some shares - it also provides for capital gains arising from the alienation of other property to be taxed in accordance with the domestic law of each country [Article 6] ;

·          allowance of tax credits for the underlying tax paid in respect of non-portfolio dividends [Article 9] ; and

·          a most favoured nation provision which provides that if Australia should subsequently conclude an agreement with a third country granting more favourable treatment in relation to certain measures, the 2 Governments will enter into negotiations with a view to providing similar treatment to Malaysia [Article 9, paragraph 8] .

2.14       The Protocol will enter into force on the last of the dates on which the Australian and Malaysian Governments exchange notes through the diplomatic channel notifying each other that the last of such things has been done as is necessary to give the Protocol the force of law in the respective countries. That notification can only be given, in the case of Australia, after this Bill has passed through Parliament and been given Royal Assent, and the 15 day sitting rule in respect of proposed treaty actions has been satisfied. On entry into force of the Protocol, it will thereafter have effect:

·          with respect to tax sparing and underlying tax credit relief generally, for the tax on income of any year of income beginning on or after 1 July 1987 in the case of Australia, and in respect of underlying tax credit relief for any year of assessment beginning on or after 1 January 1988 in the case of Malaysia [Article 10, sub-paragraphs 1(a)(i) and 1(b)(i) ] ;

·          with respect to tax sparing relief for Malaysian tax forgone in accordance with section 35 or 37 of the Promotion of Investments Act 1986 of Malaysia, for tax on income of any year of income beginning on or after 1 July 1985 [Article 10, sub-paragraph 1(a)(ii)] ;

·          with respect to fees for the furnishing of services, for the tax on income of any year of income beginning on or after 1 July 1993 in the case of Australia, and for any year of assessment beginning on or after 1 January 1994 in the case of Malaysia [Article 10, sub-paragraphs 1(a)(iii) and 1(b)(ii)] ; and

·          in any other case, with respect to income of any year of income beginning on or after 1 July in the calendar year next following that in which the Protocol enters into force in the case of Australia, and for any year of assessment beginning on or after 1 January in the second calendar year following the calendar year in which the Protocol enters into force in the case of Malaysia [Article 10, sub-paragraphs 1(a)(iv) and 1(b)(iii)] .

2.15       The entry into force provisions of the Protocol are subject, however, to a saving provision which preserves the application of the articles of the 1980 Agreement for stipulated periods where those articles would afford greater relief to a taxpayer than the 1980 Agreement as amended by the Protocol. The saving provision preserves the application of the articles of the 1980 Agreement in respect of income of any year of income (year of assessment in the case of Malaysia) beginning before the entry into force of the Protocol. [Article 10(2)]

Protocol to the 1980 Agreement

2.16       This Protocol contains a number of amendments to the 1980 Agreement. The main amendments deal with taxation of fees for technical services and tax sparing relief. Other amendments vary or extend parts of the 1980 Agreement to update it along the lines of Australia’s more recently concluded comprehensive taxation agreements with other countries. The Protocol will form an integral part of the 1980 Agreement when it enters into force.

ARTICLE 1

Definitions

2.17       Article 1 of the Protocol will replace sub-paragraphs 1(a) and 1(b) of Article 3 of the 1980 Agreement with new sub-paragraphs 1(a) and 1(b) . Those sub-paragraphs set out revised definitions of Australia and Malaysia.

2.18       As with Australia’s other modern taxation agreements, Australia is defined as including certain external territories and areas of the continental shelf. By reason of this definition, Australia preserves its taxing rights over mineral exploration and mining activities carried on by nonresidents on the seabed and subsoil of the relevant continental shelf areas (under section 6AA of the Income Tax Assessment Act 1936 (ITAA 1936), certain sea installations and offshore areas are to be treated as part of Australia). The definition is also relevant to the taxation by Australia of shipping profits in accordance with Article 8 of the 1980 Agreement.

2.19       The revised definition of Australia will include the Territory of Heard Island and McDonald Islands. This Territory was not included in the 1980 Agreement and earlier Australian agreements, due to an oversight. The Territory was transferred to Australia from the United Kingdom on 26 December 1947.

Substantially similar taxes

2.20       Article 1 of the Protocol will also make a technical amendment to paragraph 3 of Article 3 of the 1980 Agreement.

2.21       The amendment will not disturb the basic general rule of interpretation contained in the paragraph that terms in the 1980 Agreement that are otherwise undefined have, in relation to the application of the 1980 Agreement by each country, their meaning according to the domestic law (unless the context indicates otherwise). It will merely clarify that this refers to the meaning under the domestic law as in force from time to time. This amendment will bring the 1980 Agreement into line with the current OECD Model Tax Convention on Income and on Capital and Australia’s more recently negotiated agreements. Its purpose is to guard against any argument that the undefined terms be limited to the meaning they had in the respective domestic laws at the time of signature of the 1980 Agreement.

ARTICLE 2

Permanent establishments - furnishing of services

2.22       Article 2 of the Protocol will amend Article 5 of the 1980 Agreement by adding new sub-paragraph 4(c) . As with certain other recently concluded tax treaties, this sub-paragraph provides that the furnishing, by an enterprise of one country, of services including consultancy services, will constitute a permanent establishment in the other country only where those activities continue (for the same or a connected project) within the latter country for a period or periods aggregating more than 3 months within any 12 month period.

2.23       As agreed by Malaysia, the effect of sub-paragraph 4(c), when combined with the operation of Article 7 of the 1980 Agreement, ensures the preservation of the business profits principle in relation to the allocation between Australia and Malaysia of taxing rights over fees derived from the furnishing of technical and consultancy services.

ARTICLE 3

Income from land - definition

2.24       Article 3 of the Protocol will amend paragraph (2) of Article 6 of the 1980 Agreement by replacing it with a new provision. This new provision was proposed by Australia in order to ensure source country taxing rights are retained over payments made in relation to the exploration for, or exploitation of, natural resources.

2.25       The inclusion of the words ‘or in respect of’ in relation to natural resources are intended to ensure that Australia may tax payments which are ‘natural resource income’ for Australian tax purposes.

2.26       Natural resource income includes payments which, unlike royalties, are based on a contractual arrangement and not on the holding of any proprietary right in the natural resources concerned. The inclusion of the words ‘or in respect of’ therefore ensures that the definition of land includes not only payments in consideration for the right to exploit or to explore for natural resources, but also payments in relation to those resources where there is no proprietary right to explore/exploit the resources concerned. An example of a relevant payment is fees paid to a consultant geologist according to the gross value of minerals recovered from a mining site identified by the geologist.

ARTICLE 4

Business profits - trust beneficiaries

2.27       This article inserts a new provision (paragraph 8) in Article 7 of the 1980 Agreement.

2.28       This provision, common to Australia’s other recently negotiated comprehensive tax treaties, will clarify Australia’s right to tax a share of business profits derived by a resident of Malaysia as a beneficiary of a trust estate (other than a corporate unit trust) through which a business is carried on in Australia. It confirms that such a beneficiary is subject to tax in Australia where, in accordance with the principles set out in Article 5 of the 1980 Agreement, the trustee of the relevant trust estate has a ‘permanent establishment’ in Australia in relation to that business.

ARTICLE 5

Interest

2.29       This article makes 2 amendments to Article 11 of the 1980 Agreement.

Exemption from rate of tax

2.30       First, the words ‘or a long-term loan’ are deleted from paragraph 3 of Article 11 of the 1980 Agreement to reflect the deletion of that definition from the Malaysian Income Tax Act 1967 .

Sovereign immunity

2.31       Secondly, it provides for certain interest income that would normally qualify for exemption from taxation proceedings in the country in which it is derived under the international doctrine of sovereign immunity to be exempt from tax in that country.

ARTICLE 6

Alienation of property

2.32       Article 6 of the Protocol will replace Article 13 of the 1980 Agreement which deals with the alienation of land.

2.33       The new Article 13 deals with income, profits or gains from the alienation of property and allocates taxing rights between the respective countries in relation to income, profits or gains arising from the alienation of land (as defined in revised Article 6 of the 1980 Agreement) and other items of property.

Taxing rights

2.34       By virtue of paragraph 1, income, profits or gains from the alienation of land may be taxed by the country in which the land is situated. The definition of land and the situs rule for such property contained in revised Article 6 of the 1980 Agreement apply for purposes of this paragraph.

Permanent establishments

2.35       Paragraph 2 deals with income, profits or gains arising from the alienation of property (other than land covered by paragraph 1) forming part of the business assets of a permanent establishment of an enterprise. It also applies where the permanent establishment (alone or with the whole enterprise) is alienated. Such income, profits or gains may be taxed in the country in which the permanent establishment is situated. That treatment corresponds to the rules for taxing business profits contained in Article 7 of the 1980 Agreement.

Ships or aircraft

2.36       Paragraph 3 specifies that income, profits or gains from the alienation of ships or aircraft operated in international traffic, or associated property (other than land covered by paragraph 1) is taxable only in the country of residence of the operator of the ships or aircraft. This rule corresponds to the taxing rights allocated in Article 8 of the 1980 Agreement (i.e. that profits from the operation of ships or aircraft in international traffic are to be taxed only by the country of residence of the operator).

Shares and other interests in land-rich entities

2.37       Paragraph 4 provides that the Alienation of Property article extends to cover alienation of shares or other interests in companies, and other entities, whose assets consist principally of land (as defined in Article 6) which is situated in the other country (again, in the terms of Article 6).

2.38       This is to be the case whether the real property is held directly or indirectly through a chain of interposed entities. While not limited to chains of companies, or even chains of entities only some of which are companies, the example of chains of companies is used to make clear that the corporate veil should be lifted in examining direct or indirect ownership.

2.39       This provision responds to the tax planning opportunities exposed by the decision of the Full Federal Court in Commissioner of Taxation v. Lamesa Holdings BV (1997) 77 FCR 597. It is designed to protect Australian taxing rights over income, profits or gains on the alienation or effective alienation of Australian land (as defined) despite the presence of interposed bodies corporate or other entities.

Capital gains

2.40       Paragraph 5 is a sweep-up provision which enables each country to tax, according to its domestic law, any gains of a capital nature derived by a resident of the other country from the alienation of any property not specified in the other paragraphs of this article. It thus preserves the application of Australia’s domestic law rules in relation to the taxation of capital gains as regards the alienation of such property.

2.41       Income, profits or gains from the alienation of property that fall within the scope of this article are not affected by the ‘business profits’ provisions of Article 7 of the 1980 Agreement. In the event that the operation of new Article 13 should result in an item of income, profit or gain being subjected to tax in both countries, the country in which the person deriving the income, profit or gain is a resident (as determined in accordance with Article 4 of the 1980 Agreement) would be obliged by Article 23 of the 1980 Agreement to provide double tax relief for the tax imposed by the other country.

ARTICLE 7

Students and trainees

2.42       This article amends Article 20 of the 1980 Agreement by inserting ‘and Trainees’ after ‘Students’ in the heading and ‘or a trainee’ after ‘student’ in the text of the article. The exemption from tax in certain circumstances provided by the visited country to students is now extended to trainees.

ARTICLE 8

Sources of income and gains

2.43       This article amends Article 22 of the 1980 Agreement by inserting ‘and Gains’ after ‘Sources of Income’ in the heading and ‘or gains’ after ‘income’ in the first line of the text of the article. The reference to gains is to make it clear, in the case of Australia, that any capital gains derived by an Australian resident that may be taxed in the treaty partner country under the Alienation of Property article, and that are also taxable in Australia under Australian domestic law, qualify for credit relief in Australia in accordance with the double tax relief provisions of revised Article 23 of the 1980 Agreement by deeming those gains to be income derived from sources in the treaty partner country.

ARTICLE 9

Elimination of double taxation

2.44       This article will substitute in the 1980 Agreement a new Article 23 which will require the country of residence of the recipient of income, profits or gains which, under the 1980 Agreement, is taxable by both countries, to provide relief from double taxation on a credit basis that is broadly consistent with the current unilateral double taxation relief provisions of each country’s domestic law.

Malaysian method of relief

2.45       Paragraph 2 of new Article 23 provides for Malaysia to relieve double taxation by allowing a credit against its tax for tax paid under the law of Australia and in accordance with the 1980 Agreement on income derived by a resident of Malaysia from sources in Australia. Where a dividend is paid by an Australian resident company to a Malaysian resident company which owns 10% or more of the voting shares of the Australian company, this paragraph provides for the credit allowed by Malaysia to take into account, in addition to any Australian tax paid in respect of the dividends, the underlying Australian tax paid by the company in respect of the profits out of which the dividend is paid. The amount of credit to be allowed in Malaysia is restricted to the lesser of the Australian tax payable and the Malaysian tax applicable to the income.

Australian method of relief

2.46       Australia’s general foreign tax credit system, together with the terms of the 1980 Agreement as amended by the Protocol - particularly new Article 23 - will thus form the basis of Australia’s arrangements for relieving a resident of Australia from double taxation on income arising from sources in Malaysia. As in the case of Australia’s other double taxation agreements, the source of income rules specified in Article 22 of the 1980 Agreement (as amended by the Protocol) will, for purposes of the Agreement, also apply for Australian foreign tax credit purposes.

2.47       Effect will be given to the tax credit relief obligation on Australia under paragraph 3 of new Article 23 by application of the general foreign tax credit provisions (Division 18 of Part III) of the ITAA 1936. This will include the allowance of ‘underlying’ tax credit relief in respect of dividends paid by Malaysian resident companies to related Australian companies, including for income passing through any number of tiers of related companies, in accordance with the relevant provisions of the ITAA 1936.

2.48       Notwithstanding the credit form of relief provided for by paragraph 3 of new Article 23, the exemption with progression method of relief will be applicable, as appropriate, in relation to salary and wages and like remuneration derived by a resident of Australia during a continuous period of foreign service (as defined in subsection 23AG(7) of the ITAA 1936) in Malaysia. Other foreign source income exemptions in Australia’s domestic law will also continue to be applicable in respect of relevant Malaysian source income.

Correlative relief

2.49       Paragraph 4 relates to Article 9 of the 1980 Agreement, which allows reconstruction, for income tax purposes, of accounts of associated enterprises, and ensures that double taxation relief is available in those cases.

Tax sparing definition

2.50       A significant amendment by the Protocol is the extension of tax sparing relief to income which Malaysia exempts or taxes at a reduced rate under special incentive measures to promote economic development in Malaysia. Relevant provisions of the 1980 Agreement which provide for such relief by treating as paid for tax credit purposes tax forgone by Malaysia on certain income under specified development incentive provisions of its law, expired at the end of the 1983-1984 year of income. An exchange of Letters, anticipated to occur before the end of 1999 will extend the operation of these provisions until the end of the 1986-1987 year of income after which amendments contained in the Protocol will operate to provide new tax sparing arrangements in relation to certain designated development incentives provided by Malaysia for an additional 5 year period.

2.51       Sub-paragraph (a) of paragraph 5 defines the term Malaysian tax forgone for the purposes of the tax sparing credit, and sub-paragraphs (b) and (c) in effect limit the tax sparing credit for Malaysian tax, in relation to certain interest and royalties, to 10% of the gross amount of such income.

Deemed tax paid

2.52       Paragraph 6 provides that for the purposes of the tax sparing credit, Malaysian tax forgone as defined in paragraph 5 is to be treated as Malaysian tax paid.

Application of tax sparing provisions

2.53       By reason of paragraph 7, the tax sparing provisions outlined above will not apply after the end of the 1991-1992 income year unless Australia and Malaysia agree to extend them beyond that date through a further exchange of Letters.

Most favoured nation clause

2.54       Paragraph 8 contains a ‘most favoured nation’ provision. It provides that if Australia should subsequently conclude an agreement with a third country granting more favourable treatment in relation to tax sparing credits, or the allowance of credit for the tax paid by a company on profits out of which dividends are paid to Australian companies than that extended to Malaysia, the 2 governments will enter into negotiations with a view to extending similar treatment to Malaysia.

Malaysian cinematograph film-hire duty

2.55       By paragraph 9, Australia will allow credit for the Malaysian cinematograph film-hire duty against the Australian tax payable on film rentals derived by residents of Australia from Malaysia.

Malaysian real property gains tax

2.56       Similarly, by paragraph 10, Australia will allow credit for the Malaysian real property gains tax against the Australian tax payable on relevant gains derived by residents of Australia from Malaysia.

Article 10 - Entry into force

Date of entry into effect

2.57       This article provides for the entry into force of the Protocol. The Protocol will enter into force when the notifications between the countries that the procedures necessary to give it the force of law in the respective countries have been completed.

2.58       Once it enters into force the Protocol will form an integral part of the 1980 Agreement. The Protocol will be given the force of law in Australia by new section 11FA that is to be inserted in the Agreements Act by Schedule 2 to this Bill.

Retrospective application - tax sparing provisions extension to the 1991-1992 income year

2.59       Under sub-paragraph 1(a)(i) of this article, the Protocol will, on entry into force, have effect, subject to sub-paragraph 1(a)(ii), for the purposes of the tax sparing provisions of Article 9 of the Protocol in respect of tax on income of any year of income beginning on or after 1 July 1987 in Australia.

2.60       Under sub-paragraph 1(a)(ii) of this article, to the extent that Article 9 of the Protocol has application in respect of Malaysian tax forgone in accordance with section 35 or 37 of the Promotion of Investments Act 1986 of Malaysia, the Protocol will have effect in respect of tax on income of any year of income beginning on or after 1 July 1985.

2.61       Australian taxpayers who have received the benefit of the relevant Malaysian tax sparing concessions during the years referred to in paragraphs 2.59 and 2.60, may request a foreign tax credit determination or amended determination from the Commissioner of Taxation (the Commissioner) once the Protocol enters into force, to claim the relevant Malaysian tax forgone as a foreign tax credit.

Retrospective application - underlying tax credit relief

2.62       Sub-paragraphs 1(a)(i) and 1(b)(i) of Article 10 will also operate so that the Protocol will have effect, on its entry into force, for the purposes of underlying tax credit relief in respect of tax on income of the 1987-1988 and subsequent years of income in the case of Australia and in respect of tax for any year of assessment beginning on or after 1 January 1988 in the case of Malaysia.

2.63       In the case of Australia, the domestic underlying tax credit provisions would be applicable in any event.

Retrospective application - fees for technical services provisions

2.64       Under sub-paragraph 1(a)(iii) of Article 10, the Protocol will have effect for the purposes of sub-paragraph (c) of Article 2 of the Protocol, in respect of tax on income of any year of income beginning on or after 1 July 1993 in Australia (and by virtue of sub-paragraph 2(b)(ii), in respect of Malaysian tax for any year of assessment beginning on or after 1 January 1994). Sub-paragraph (c) of Article 2 of the Protocol amends Article 5 of the 1980 Agreement by adding new sub-paragraph (c) to paragraph 4 of Article 5.

2.65       Australian taxpayers who have experienced unrelieved double taxation in respect of technical service fee income will be able, upon entry into force of the Protocol, to seek refunds from the Malaysian authorities of the previously withheld Malaysian tax on such income for the income years concerned in situations where new sub-paragraph 4(c) of Article 5 of the 1980 Agreement does not deem those taxpayers to have a permanent establishment in Malaysia.

2.66       Australian taxpayers who are deemed to have a permanent establishment in Malaysia by virtue of new sub-paragraph 4(c) of Article 5 will, upon entry into force of the Protocol, be able to lodge a claim with the Commissioner for a foreign tax credit for the previously withheld Malaysian tax against the Australian tax payable on the Malaysian sourced income for the income years concerned.

Other income

2.67       In respect of other income, the Protocol will have effect in Australia by virtue of sub-paragraph 1(a)(iv), in relation to income of any year of income beginning on or after 1 July in the calendar year next following that in which the Protocol enters into force. It will have effect in respect of Malaysian tax by virtue of sub-paragraph 1(b)(iii), for any year of assessment beginning on or after 1 January in the second calendar year following the calendar year in which the Protocol enters into force.

Transitional provisions

2.68       Paragraph 2 of the article will protect the rights of taxpayers in the transition from the unamended 1980 Agreement to that Agreement as amended by the Protocol. Where any provision of the 1980 Agreement that is affected by the Protocol affords greater relief from tax than the corresponding provision of the Agreement as amended by the Protocol, that provision of the 1980 Agreement is to continue to have effect in Australia in relation to such income of any year of income beginning before the Protocol enters into force, and in Malaysia for any year of assessment beginning before that date.

 



C hapter

Agreement with the Slovak Republic

Main features of the Agreement

3.1         The Double Tax Agreement (DTA) between Australia and the Slovak Republic accords substantially with Australia’s recent comprehensive DTAs.

3.2         The features of the DTA include:

·          Dual resident individuals (i.e. persons, who are residents of both Australia and the Slovak Republic according to the domestic law of each country) are, in accordance with specified criteria, to be treated for the purposes of the DTA as being residents of only one country.

·          Income from real (immovable) property may be taxed in full by the country in which the property is situated. Income from real property for these purposes includes natural resource royalties.

·          Business profits are generally to be taxed only in the country of residence of the recipient unless they are derived by a resident of one country through a branch or other prescribed ‘permanent establishment’ in the other country, in which case the other country may tax the profits.

·          The furnishing of services will be deemed to be a permanent establishment where the services are performed by an enterprise of one country in the other country for a period aggregating more than 6 months in any 12 month period.

·          Profits from the international operations of ships and aircraft are to be taxed only in the country of residence of the operator.

·          Profits of associated enterprises may be taxed on the basis of dealings at arm’s length .

·          Dividends, interest and royalties may generally be taxed in both countries, but there are limits on the tax that the country in which the dividend, interest or royalty is sourced may charge on such income flowing to residents of the other country who are beneficially entitled to that income. These limits are 15% for dividends and 10% for both interest and royalties.

·          Income, profits or gains from the alienation of real property may be taxed in full by the country in which the property is situated. Subject to that rule and other specific rules in relation to business assets and some shares, capital gains are to be taxed in accordance with the domestic law of each country.

·          Income from professional services and other similar activities provided by an individual will generally be taxed only in the country of residence of the recipient. However, remuneration derived by a resident of one country in respect of professional services rendered in the other country may be taxed in the other country, if it is derived through a fixed base of the person concerned in the latter country.

·          Income from dependent personal services, that is, employee’s remuneration, will generally be taxable in the country where the services are performed. However, where the services are performed during certain short visits to one country by a resident of the other country, the income will be exempt in the country visited.

·          Directors’ fees and similar payments may be taxed in the country of residence of the paying company.

·          Income derived by entertainers and sportspersons may generally be taxed by the country in which the activities are performed.

·          Pensions and annuities may be taxed only in the country of residence of the recipient.

·          Government service remuneration will generally be taxed only in the country that pays the remuneration. However, the remuneration may be taxed in the other country in certain circumstances where the services are rendered in that other country.

·          Income of visiting students and trainees will be exempt from tax in the country visited insofar as it consists of payments made from abroad for the purposes of their maintenance, or education or training.

·          Income not expressly mentioned (i.e. income not dealt with by other articles) may generally be taxed in both countries, with the country of residence of the recipient providing double tax relief.

·          Consultation and exchange of information between the 2 taxation authorities is authorised by the DTA.

·          Double taxation relief for income which under the DTA may be taxed by both countries is required to be provided by the country in which the taxpayer is resident under the terms of the DTA as follows:

-           in Australia , by allowing a credit against Australian tax for Slovak tax paid on income derived by a resident of Australia from sources in the Slovak Republic. In the case of certain dividend payments from a company resident in the Slovak Republic to a related Australian resident company, the Slovak tax to be credited includes the ‘underlying tax’ in respect of the profits out of which the dividend was paid;

-           in the Slovak Republic , by allowing a deduction against Slovak tax for the Australian tax paid on income derived by a resident of the Slovak Republic from sources in Australia.

·          In the case of Australia, effect will be given to the double tax relief obligations arising under the DTA by application of the general foreign tax credit provisions of Australia’s domestic law, or the relevant exemption provisions of that law where applicable.

Agreement between Australia and the Slovak Republic

Article 1 - Personal scope

Scope

3.3         This article establishes the scope of the application of the DTA by providing for it to apply to persons (defined to include companies) who are residents of one or both of the countries. It generally precludes extra-territorial application of the DTA.

3.4         The application of the DTA to persons who are dual residents (i.e. residents of both countries) is dealt with in Article 4.

Article 2 - Taxes covered

Taxes covered

3.5         This article specifies the existing taxes of each country to which the DTA applies. These are, in the case of Australia:

·          the Australian income tax; and

·          the resource rent tax in respect of offshore petroleum projects.

3.6         It is specifically stated that the article applies only to taxes imposed under the federal law of Australia. This is to ensure that the DTA does not bind Australian States and Territories and applies only to federal taxes.

3.7         For the Slovak Republic, the DTA applies to:

·          the tax on income of individuals; and

·          the tax on income of legal persons.

3.8         In the case of Australia, income tax (including that imposed on capital gains) and resource rent tax are covered by the DTA. Sales tax, goods and services tax, fringe benefits tax, wool tax and levies, customs duties, State tax and duties and estate tax and duties are not covered by the DTA. [Paragraph 1]

Identical or substantially similar taxes

3.9         The application of the DTA will be automatically extended to any identical or substantially similar taxes which are subsequently imposed by either country in addition to, or in place of, the existing taxes. A duty is imposed on Australia and the Slovak Republic to notify each other within a reasonable time of any significant changes to their respective laws to which the DTA applies. [Paragraph 2]

Article 3 - General definitions

Definition of Australia

3.10       As with Australia’s other modern taxation agreements, Australia , when used in a geographical sense, is defined to include certain external territories and areas of the continental shelf. By reason of this definition, Australia preserves its taxing rights, for example, over mineral exploration and mining activities carried on by nonresidents on the seabed and subsoil of the relevant continental shelf areas (under section 6AA of the Income Tax Assessment Act 1936 (ITAA 1936), certain sea installations and offshore areas are to be treated as part of Australia). The definition is also relevant to the taxation by Australia and the Slovak Republic of shipping profits in accordance with Article 8 of the DTA. [Sub-paragraph 1(b)]

Definition of company

3.11       The definition of company in the DTA accords with Australia’s DTA practice. It reflects the fact that Australia’s domestic tax law does not specifically use the expression body corporate for tax purposes.

3.12       The Australian tax law treats certain trusts (public unit trusts and public trading trusts) and corporate limited partnerships as companies for income tax purposes. These entities will be regarded as companies for the purposes of the DTA. [Sub-paragraph 1(d)]

Definition of tax

3.13       For the purposes of the DTA, the term tax does not include any amount of penalty or interest imposed under the respective domestic law of the 2 countries. This is important in determining a taxpayer’s entitlement to a foreign tax credit under the double tax relief provisions of Article 23 (Methods of elimination of double taxation) of the DTA.

3.14       In the case of a resident of Australia, any penalty or interest component of a liability determined under the domestic taxation law of the Slovak Republic with respect to income that the Slovak Republic is entitled to tax under the DTA, would not be a creditable ‘Slovak tax’ for the purposes of Article 23(1) of the DTA. This is in keeping with the meaning of foreign tax in the ITAA 1936 (subsection 6AB(2) - Foreign Income and Foreign Tax). Accordingly, such a penalty or interest liability would be excluded from calculations when determining the Australian resident taxpayer’s foreign tax credit entitlement under Article 23(1) (pursuant to Division 18 of Part III of the ITAA 1936 - Credits in Respect of Foreign Tax). [Sub-paragraph 1(j)]

Terms not specifically defined

3.15       Where a term is not specifically defined within this DTA, that term (unless used in a context that requires otherwise) is to be taken to have the same interpretative meaning as it has under the domestic law of the country applying the DTA at the time of its application, with the meaning it has under the taxation law of the country having precedence over the meaning it may have under other domestic laws.

3.16       If a term is not defined in the DTA, but has an internationally understood meaning in double tax treaties and a meaning under the domestic law the context would normally require that the international meaning be applied. [Paragraph 2]

Article 4 - Resident

Residential status

3.17       This article sets out the basis by which the residential status of a person is to be determined for the purposes of the DTA. Residential status is one of the criteria for determining each country’s taxing rights and is a necessary condition for the provision of relief under the DTA. The concept of who is a resident according to each country’s taxation law provides the basic test. [Paragraph 1]

3.18       In the Australian context this means that Norfolk Island residents, who are generally subject to Australian tax on Australian source income only, will not be residents of Australia for the purposes of the DTA. Accordingly, the Slovak Republic will not have to forgo tax in accordance with the DTA on income derived by residents of Norfolk Island from sources in the Slovak Republic (which will not be subject to Australian tax). [Paragraph 2]

Dual residents

3.19       The article also includes a set of tie-breaker rules for determining how residency is to be allocated to one or other of the countries for the purposes of the DTA if a taxpayer, whether an individual, a company or other entity, qualifies as a dual resident, that is, as a resident under the domestic law of both countries.

3.20       The tie-breaker rules for individuals apply certain tests, in a descending hierarchy, for determining the residential status (for the purposes of the DTA) of an individual who is a resident of both countries under their respective domestic laws.

3.21       These rules, in order of application, are:

·          if the individual has a permanent home in only one of the countries, the person is deemed to be a resident solely of that country for the purposes of the DTA;

·          if the individual has a permanent home available in both countries, or does not have a permanent home available in either country, and the person has an habitual abode in one of the countries, the person is deemed to be resident solely in the country of the habitual abode for the purposes of the DTA;

·          if residential status cannot be determined on the basis of an habitual abode, the person’s economic and personal relations with Australia and the Slovak Republic are considered, and the person is deemed to be a resident solely of the country with which his or her relations are closer for the purposes of the DTA.

[Paragraph 3]

3.22       When considering the degree of the person’s personal and economic relations with either Australia or the Slovak Republic, due regard is to be given to that person’s citizenship or nationality. [Paragraph 4]

3.23       However, in relation to each country, a dual resident remains a resident of that country for the purposes of its domestic law and subject to its tax as such so far as the DTA allows.

3.24       Where a non-individual (such as a body corporate) is a resident of both countries for their domestic tax purposes, the entity will be deemed to be a resident of the country in which its place of effective management is situated. [Paragraph 5]

Article 5 - Permanent establishment

Role and definition

3.25       Application of various provisions of the DTA (principally Article 7 relating to business profits) is dependent upon whether a person who is a resident of one country has a ‘permanent establishment’ in the other, and if so, whether income derived by the person in the other country is attributable or effectively connected with carrying on a business through that ‘permanent establishment’. The definition of the term ‘permanent establishment’ which this article embodies, corresponds generally with definitions of the term in Australia’s more recent DTAs.

Meaning of permanent establishment

3.26       The primary meaning of the term ‘permanent establishment’ is expressed as being a fixed place of business through which the business of an enterprise is wholly or partly carried on. A ‘permanent establishment’ must comply with the following requirements:

·          there must be a place of business;

·          the place of business must be fixed (both in terms of physical location and in terms of time);

·          the business of the enterprise must be carried on through this fixed place.

[Paragraph 1]

3.27       Other paragraphs of the article are concerned with elaborating on the meaning of the term by giving examples (by no means intended to be exhaustive) of what may constitute a ‘permanent establishment’ - for example:

·          an office;

·          a workshop; or

·          a mine.

As paragraph 2 is subordinate to paragraph 1, the examples listed will only constitute a ‘permanent establishment’ if the primary definition in paragraph 1 is satisfied. [Paragraph 2]

Agricultural, pastoral or forestry activities

3.28       All of Australia’s comprehensive DTAs include as a ‘permanent establishment’ an agricultural, pastoral or forestry property. This reflects Australia’s policy of retaining taxing rights over exploitation of Australian land for the purposes of primary production. This approach ensures that the arm’s length profits test provided for in Article 7 (Business profits) apply to the determination of profits derived from these activities. This position is also reflected in this DTA. [Sub-paragraph 2(g)]

Furnishing of services

3.29       The furnishing of services, including consultancy services, will constitute a ‘permanent establishment’ where the services are performed (for the same or a connected project) by an enterprise of one country in the other country for a period aggregating more than 6 months in any 12 month period. [Sub-paragraph 2(i)]

Building sites or construction, installation or assembly projects

3.30       Also consistent with Australia’s DTA practice, sub-paragraph 2(h) of the DTA includes building sites or construction, installation or assembly projects which exist for more than 12 months as examples of a ‘permanent establishment’. Building sites, construction, installation and assembly projects lasting less than 12 months, which nevertheless meet the requirements of other ‘permanent establishment’ rules will be ‘permanent establishments’.

3.31       The term a building site or construction, installation or assembly project covers constructional activities such as excavating or dredging. The term ‘building site’ can only mean such work as is directly connected with the erection of buildings and similar projects (earth work, masonry, painting, roofing, glazing and plumbing). Planning and supervision are certainly part of the building site if carried out by the construction contractor. However, planning and supervision of work does not represent a building site if carried out by another enterprise (see paragraph 3.36 regarding sub-paragraph 4(a) of Article 5).

Preparatory and auxiliary activities

3.32       Certain activities are deemed not to give rise to a permanent establishment, for example, use of facilities or maintenance of a stock of goods solely for storage, display or irregular delivery, or preparatory or auxiliary activities.

3.33       Generally these activities are of a preparatory or auxiliary character and are unlikely to give rise to substantial profits. The necessary economic link between the activities of the enterprise and the country in which the activities are carried on does not exist in these circumstances.

3.34       Unlike the OECD Model Tax Convention on Capital and Income (the OECD Model), which provides that the listed activities are deemed not to constitute a ‘permanent establishment’, the DTA incorporates the Australian DTA approach of stating that an enterprise will not be deemed to have a ‘permanent establishment’ merely by reason of such activities. This is to prevent the situation where enterprises structure their business so that most of their activities fall within the exceptions when - viewed as a whole - the activities ought to be regarded as a ‘permanent establishment’.

3.35       Another feature consistent with Australia’s DTA practice is that sub-paragraph 4(f) of the OECD Model - dealing with combinations of the activities in sub-paragraphs (a) to (e) - is not included. Australia does not consider that an enterprise undertaking multiple functions of the kind indicated in sub-paragraphs (a) to (e) could reasonably be regarded as only engaged in preparatory or auxiliary activities. [Paragraph 3]

Deemed permanent establishments

Supervisory activities

3.36       Supervisory activities carried on for more than 12 months in connection with a building site or a construction, installation or assembly project are deemed to constitute a ‘permanent establishment’. Australia has a reservation on Article 5 of the OECD Model reflecting this position. The rationale for inclusion of this provision is the prevalence of the use in Australia of imported expertise in relation to supervision of such projects. [Sub-paragraph 4(a)]

Substantial equipment

3.37       Under sub-paragraph 4(b) an enterprise is deemed to have a ‘permanent establishment’ in a State if substantial equipment is being used in that State by, for or under contract with the enterprise.

3.38       This position is reflected in Australia’s reservation to the OECD Model and one effect is to further protect Australia’s right to tax income from natural resources. Australia’s experience is that the ‘permanent establishment’ provision in the OECD Model may be inadequate to deal with high value activities involved in the development of natural resources, particularly in offshore regions.

3.39       Some examples of substantial equipment would include:

·          large industrial earth moving equipment or construction equipment used in road building, dam building or powerhouse construction etc.;

·          manufacturing or processing equipment used in a factory;

·          oil and drilling rigs, platforms and other structures used in the petroleum/mining industry; and

·          grain harvesters and other large agricultural machinery.

3.40       For the purposes of the application of Article 7(1) the enterprise is deemed to carry on business through the substantial equipment ‘permanent establishment’. [Sub-paragraph 4(b)]

Dependent agents

3.41       Sub-paragraph 5(a) reflects Australia’s DTA practice in relation to a person who acts on behalf of an enterprise of another country of deeming that person to constitute a ‘permanent establishment’ if that person has and habitually exercises an authority to conclude contracts on behalf of the enterprise. This will apply unless the agent’s activities are limited to the purchase of goods or merchandise for the enterprise, or the agent is an ‘independent agent’ to whom paragraph 6 applies. [Sub-paragraph 5(a)]

Cost-toll operations

3.42       The inclusion of sub-paragraph 5(b) is consistent with another of Australia’s reservations to the OECD Model. It deals with so-called cost-toll situations, under which a mineral plant, for example, refines minerals at cost, so that the plant operations produce no Australian profits. Title to the refined product remains with the mining consortium and profits on sale are realised mainly outside of Australia.

3.43       Sub-paragraph 5(b) deems such a plant to be a ‘permanent establishment’ because the manufacturing or processing activity (which gives the processed minerals their real value) is conducted in Australia, and therefore Australia should have taxing rights over business profits arising from the sale of the processed minerals to the extent that they are attributable to the processing activity carried on in Australia. This sub-paragraph prevents an enterprise which carries on very substantial manufacturing or processing activities in a country through an intermediary from claiming that it does not have a ‘permanent establishment’ in that country.

3.44       The inclusion of this sub-paragraph is insisted upon by Australia in its DTAs and is consistent with Australia’s policy of retaining taxing rights over exploitation of its mineral resources. [Sub-paragraph 5(b) ]

Independent agents

3.45       Business carried on through an independent agent does not, of itself, constitute a ‘permanent establishment’, provided that the independent agent is acting in the ordinary course of that agent’s business as such an agent. [Paragraph 6]

Subsidiary companies

3.46       Generally a subsidiary company will not be a ‘permanent establishment’ of its parent company. A subsidiary, being a separate legal entity, would not usually be carrying on the business of the parent company but rather its own business activities. However a subsidiary company gives rise to a ‘permanent establishment’ if the subsidiary permits the parent company to operate from its premises such that the tests in paragraph 1 are met, or acts as an agent such that a dependent agent ‘permanent establishment’ is constituted. [Paragraph 7]

Other articles

3.47       The principles set down in this article are also to be applied in determining whether a ‘permanent establishment’ exists in a third country or whether a third country has a ‘permanent establishment’ in Australia (or in the Slovak Republic) when applying the source rule contained in:

·          paragraph 5 of Article 11 ( Interest ); and

·          paragraph 5 of Article 12 ( Royalties ).

[Paragraph 8]

Article 6 - Income from real (immovable) property

Where income from real property is taxable

3.48       This article provides that the income of a resident of one country from real property situated in the other country may be taxed by the other country. Thus income from real property in Australia will be subject to Australian tax laws. [Paragraph 1]

Definition

3.49       Income from real property is effectively defined as extending, in the case of both Australia and the Slovak Republic, to:

·          the direct use, letting or use in any other form of real property, a lease of land and any other interest in or over land (including exploration and mining rights); and

·          royalties and other payments relating to the exploration for or exploitation of mines or quarries or other natural resources or rights in relation thereto.

[Paragraph 2]

Deemed situs

3.50       Under Australian law the situation of an interest in land, such as a lease, is not necessarily where the underlying property is situated - there may not necessarily be a situs. Paragraph 3 puts the situation of the interest or right beyond doubt. [Paragraph 3]

Real property of an enterprise and of persons performing independent personal services

3.51       The operation of this article extends to income derived from the use or exploitation of real property of an enterprise and income derived from real property that is used for the performance of independent personal services.

3.52       Accordingly, application of this article (when read with Articles 7 and 14) to such income ensures that the country in which the real property is situated may impose tax on the income derived from that property by:

·          an enterprise of the other country; or

·          an independent professional person resident in that other country,

irrespective of whether or not that income is attributable to a ‘permanent establishment’ of such an enterprise, or ‘fixed base’ of such a person, situated in the firstmentioned country. [Paragraph 4]

Article 7 - Business profits

3.53       This article is concerned with the taxation of business profits derived by an enterprise that is a resident of one country from sources in the other country.

3.54       The taxing of these profits depends on whether they are attributable to the carrying on of a business through a ‘permanent establishment’ in the other country. If a resident of one country carries on business through a ‘permanent establishment’ (as defined in Article 5) in the other country, the country in which the ‘permanent establishment’ is situated may tax the profits of the enterprise that are attributable to that ‘permanent establishment’.

3.55       If a taxpayer who is a resident of one country carries on business through an enterprise that does not have a ‘permanent establishment’ in the other country, the general principle of the article is that the taxpayer will not be liable to tax in the other country on the business profits of that enterprise (but see the explanation in paragraphs 3.59 and 3.60 concerning paragraph 6 of the article). [Paragraph 1]

Determination of business profits

3.56       Profits of a ‘permanent establishment’ are to be determined for the purposes of the article on the basis of arm’s length dealing. The provisions in the DTA correspond to international practice and the comparable provisions in Australia’s other DTAs. [Paragraphs 2 and 3]

3.57       No profits are to be attributed to a ‘permanent establishment’ merely because it purchases goods or merchandise for the enterprise. Accordingly, profits of a ‘permanent establishment’ derived from business activities carried on in its own right will not be increased by adding to them any profits attributable to the purchasing activities undertaken for the head office. It follows, of course, that any expenses incurred by the ‘permanent establishment’ in respect of those purchasing activities will not be deductible in determining the taxable profits of the ‘permanent establishment’. [Paragraph 4]

Inadequate information

3.58       This article allows for the application of the domestic law of the country in which the profits are sourced (e.g. Australia’s Division 13 of the ITAA 1936) where, due to inadequate information, the correct amount of profits attributable on the arm’s length principle basis to a ‘permanent establishment’ cannot be determined or can only be ascertained with extreme difficulty. [Paragraph 5]

Income or gains dealt with under other articles

3.59       Where income or gains are otherwise specifically dealt with under other articles of the Agreement the effect of those particular articles is not overridden by this article.

3.60       This provision lays down the general rule of interpretation that categories of income or gains which are the subject of other articles of the DTA (e.g. shipping, dividends, interest, royalties and alienation of property) are to be treated in accordance with the terms of those articles and as outside the scope of this article (except where otherwise provided - e.g. by Article 10(5) where the income is effectively connected to a ‘permanent establishment’). [Paragraph 6]

Insurance with nonresidents

3.61       Each country has the right to continue to apply any special provisions in its domestic law relating to the taxation of income from insurance. However, if the relevant law in force in either country at the date of signature of the DTA is varied (otherwise than in minor respects so as not to affect its general character), the countries must consult with each other with a view to agreeing to any amendment of this paragraph that may be appropriate. An effect of this paragraph is to preserve, in the case of Australia, the application of Division 15 of Part III of the ITAA 1936 (Insurance with Non-residents). [Paragraph 7]

Trust beneficiaries

3.62       The principles of this article will apply to business profits derived by a resident of one of the States (directly or through one or more interposed trust estates) as a beneficiary of a trust estate. [Paragraph 8]

Example 3.1

In accordance with this article, Australia has the right to tax a share of business profits, originally derived by a trustee of a trust estate (other than a trust estate that is treated as a company for tax purposes) from the carrying on of a business through a ‘permanent establishment’ in Australia, to which a resident of the Slovak Republic is beneficially entitled under the trust estate. Paragraph 8 ensures that such business profits will be subject to tax in Australia where, in accordance with the principles set out in Article 5, the trustee of the relevant trust estate has a ‘permanent establishment’ in Australia in relation to that business.

Article 8 - Ships and aircraft

3.63       The main effect of this article is that the right to tax profits from the operation of ships or aircraft in international traffic, including profits derived from participation in a pool service or other profit sharing arrangement, is generally reserved to the country in which the operator is a resident for tax purposes. [Paragraph 1]

Non transport operations

3.64       However, the article reflects Australian treaty policy to reserve to the other country the right to tax profits from internal traffic, profits from other coastal and continental shelf activities including non transport shipping and aircraft activities within its own waters.

3.65       Thus, the term transport is not used in the title of the article, as the article applies to survey ships, oil drilling ships etc. where transport is not necessarily involved. [Paragraph 2]

Paragraphs 1 and 2 also apply to profits derived from participation in:

·          a pool service;

·          joint transport operating organisation; or

·          an international operating agency.

3.66       Thus, the country in which the participant resides has the right to tax the participant’s share of the profits, except where the profits are solely from internal operations, when the source country has the right to tax the profits. [Paragraph 3]

3.67       By reason of the definition of Contracting State contained in Article 3 and the terms of paragraph 4 of this article, any shipments by sea or air from a place in Australia (including the continental shelf areas and external territories) for discharge at another place in or for return to that place in Australia, is to be treated as forming part of internal traffic. [Paragraph 4]

Example 3.2

Profits derived from a shipment of goods taken on board (during the course of an international voyage between a place in the Slovak Republic and Sydney) at Perth for delivery to Melbourne, would be profits from internal traffic. As such, 5% of the amount paid in respect of the internal traffic carriage would be deemed to be taxable income of the operator for Australian tax purposes pursuant to Division 12 of Part III of the ITAA 1936.

Article 9 - Associated enterprises

Re-allocation of profits

3.68       This article deals with associated enterprises (parent and subsidiary companies and companies under common control). It authorises the re-allocation of profits between related enterprises in Australia and the Slovak Republic on an arm’s length basis where the commercial or financial arrangements between the enterprises differ from those that might be expected to operate between independent enterprises dealing wholly at arm’s length with one another.

3.69       The article would not generally authorise the rewriting of accounts of associated enterprises where it can be satisfactorily demonstrated that the transactions between such enterprises have taken place on normal, open market commercial terms. [Paragraph 1]

3.70       Each country retains the right to apply its domestic law relating to the determination of the tax liability of a person (e.g. Australia’s Division 13 of the ITAA 1936) to its own enterprises, provided that such provisions are applied, so far as it is practicable to do so, consistently with the principles of the article. [Paragraph 2]

3.71       Australia’s domestic law provisions relating to international profit shifting arrangements were revised in 1981 in order to deal more comprehensively with arrangements under which profits are shifted out of Australia, whether by transfer pricing or other means. The broad scheme of the revised provisions is to impose arm’s length standards in relation to international dealings, but where the Commissioner of Taxation (the Commissioner) cannot ascertain the arm’s length consideration, it is deemed to be such amount as the Commissioner determines. Paragraph 2 is designed to preserve the application of those domestic law provisions.

Correlative adjustments

3.72       Where a re-allocation of profits is made (either under this article or, by virtue of paragraph 2, under domestic law) so that the profits of an enterprise of one country are adjusted upwards, a form of double taxation would arise if the profits so re-allocated continued to be subject to tax in the hands of an associated enterprise in the other country. To avoid this result, the other country is required to make an appropriate compensatory adjustment to the amount of tax charged on the profits involved to relieve any such double taxation.

3.73       It would generally be necessary for the affected enterprise to apply to the competent authority of the country not initiating the re-allocation of profits for an appropriate compensatory adjustment to reflect the re-allocation of profits made by the other treaty partner country. If necessary, the competent authorities of Australia and the Slovak Republic will consult with each other to determine the appropriate adjustment. [Paragraph 3]

Article 10 - Dividends

3.74       This article broadly allows both countries to tax dividends flowing between them but in general limits the rate of tax that the country of source may impose on dividends payable by companies that are residents of that country under its domestic law to beneficial owners resident in the other country. [Paragraph 1]

3.75       Under this article, Australia will reduce its rate of withholding tax on unfranked dividends paid by Australian resident companies to residents of the Slovak Republic from the 30% rate in domestic law to 15% of the gross amount of the dividends. Dividend payments will remain free of withholding tax under Australia’s domestic law to the extent to which they are franked. [Paragraph 2]

Exception to limitation

3.76       The limitation on the tax of the country in which the dividend is sourced does not apply to dividends derived by a resident of the other country who has a ‘permanent establishment’ or ‘fixed base’ in the country from which the dividends are derived, if the holding giving rise to the dividends is effectively connected with that ‘permanent establishment’ or ‘fixed base’.

3.77       Where the dividends are so effectively connected, they are to be treated as ‘business profits’ or ‘income from independent personal services’ and therefore subject to the full rate of tax applicable in the country in which the dividend is sourced (in accordance with the provisions of Article 7 or Article 14, as the case may be). In practice, however, under changes made to Australia’s domestic law with the introduction from 1 July 1987 of a full imputation system of company taxation, such dividends, to the extent that they are franked dividends, remain exempt from Australian tax, while unfranked dividends will be subject to withholding tax at the rate of 15% instead of being taxed by assessment. [Paragraph 4]

Extra-territorial application precluded

3.78       The extra-territorial application by either country of taxing rights over dividend income is precluded by providing, broadly, that one country (the first country) will not tax dividends paid by a company resident solely in the other country, unless:

·          the person deriving the dividends is a resident of the first country; or

·          the shareholding giving rise to the dividends is effectively connected with a ‘permanent establishment’ or ‘fixed base’ in the first country.

3.79       An example of the effect of this paragraph is that Australia may not tax dividends paid by a Slovak company to a resident of the Slovak Republic out of profits derived from Australian sources, otherwise than through a ‘permanent establishment’ or a ‘fixed base’.

3.80       However, the exemption does not apply where the dividend paying company is a resident of both Australia and the Slovak Republic. This proviso ensures that Australia retains the right to tax dividends paid to a person resident outside of both countries by a company which is a resident of Australia under its domestic law, notwithstanding that the company is deemed to be a resident of the Slovak Republic for the purposes of the DTA under the dual resident tie-breaker test for companies contained in Article 4. [Paragraph 5]

Article 11 - Interest

Rate of tax

3.81       This article provides for interest income to be taxed by both countries but requires the country of source to generally limit its tax to 10% of the gross amount of the interest where a resident of the other country is the beneficial owner of the interest. [Paragraphs 1 and 2]

3.82       The limitation of the source country tax rate to 10% accords with the general rate of interest withholding tax applicable under Australia’s domestic law.

Definition of interest

3.83       The term interest is defined for the purposes of the article in a way that, in relation to Australia, encompasses items of income such as discounts on securities and payments under certain hire purchase agreements which are treated for Australian tax purposes as interest or amounts in the nature of interest. [Paragraph 3]

Interest effectively treated as business profits

3.84       Interest derived by a resident of one country which is effectively connected to a ‘permanent establishment’ or ‘fixed base’ of that person in the other country, will form part of the business profits of that ‘permanent establishment’ or ‘fixed base’ and be subject to the provisions of Article 7 ( Business profits ) or Article 14 ( Independent personal services ). Accordingly, the 10% tax rate limitation does not apply to such interest in the country in which the interest is sourced. [Paragraph 4]

Deemed source rules

3.85       Interest source rules are set are in the article. Those rules operate to allow Australia to tax interest to which a resident of the Slovak Republic is beneficially entitled where the interest is paid by a resident of Australia. Australia may also tax interest paid by a resident of the Slovak Republic to which another Slovak Republic resident is beneficially entitled if it is an expense incurred by the payer of the interest in carrying on a business in Australia through a ‘permanent establishment’. However, consistent with Australia’s interest withholding tax provisions, an Australian source is not deemed in respect of interest that is an expense incurred by an Australian resident in carrying on a business through a ‘permanent establishment’ outside Australia. [Paragraph 5]

Related persons

3.86       This article also contains a general safeguard against payments of excessive interest - in cases where there is a special relationship between the persons associated with a loan transaction - by restricting the 10% tax rate limitation in the country in which the interest is sourced to the amount of the interest which it might be expected would have been agreed upon if the parties to the loan agreement were dealing with one another at arm’s length. Any excess part of the interest remains taxable according to the domestic law of each country but subject to the other articles of this DTA. [Paragraph 6]

Article 12 - Royalties

Rate of tax

3.87       The article in general allows both countries to tax royalty flows but limits the tax of the country of source to 10% of the gross amount of royalties paid or credited to residents of the other country beneficially entitled to the royalties. [Paragraphs 1 and 2]

3.88       The 10% rate limitation is not to apply to natural resource royalties, which, in accordance with Article 6, are to remain taxable in the country of source without limitation of the tax that may be imposed.

3.89       In the absence of a DTA, Australia’s taxes royalties paid to nonresidents at 30% of the gross royalty.

Definition of royalties

3.90       The definition of royalties in the DTA reflects the definition in Australia’s domestic income tax law. The definition encompasses payments for the use of, or the right to use industrial, commercial or scientific equipment. It also includes payments for the supply of scientific, technical, industrial or commercial know-how but not payments for services rendered. Payments made for the right to copy or adapt computer software in a manner which would, without the permission of the copyright owner, constitute an infringement of copyright, also constitute royalty payments. [Paragraph 3]

Payments for the supply of know-how versus payments for services rendered

3.91       It is considered that a German Supreme Court decision (Bundesfinanzhof (No. IR 44/67) of 16 December 1970) provides a definitive test to distinguish between a know-how contract and a contract for services. A know-how contract, it was held, involved the supply by a person of his or her know-how to the paying entity (e.g. teaching a personal expertise), whereas in a contract for services, although it may involve the use of know-how , that know-how is applied by the person in the performance of his or her services.

3.92       Payments for design, engineering or construction of plant or building, feasibility studies, component design and engineering services may generally be regarded as being in respect of a contract for services, unless there is some provision in the contract for imparting techniques and skills to the buyer .

3.93       In cases where both know-how and services are supplied under the same contract, if the contract does not separately provide for payments in respect of know-how and services, an apportionment of the 2 elements of the contract may be possible.

3.94       Payments for services rendered are to be treated under Article 7 ( Business profits ) or Article 15 ( Independent personal services ).

Forbearance

3.95       Consistently with Australian tax treaty practice, sub-paragraph 3(h) expressly treats as a royalty, amounts paid or credited in respect of forbearance to grant to third persons, rights to use property covered by the royalty article. This is designed to prevent arrangements along the lines of those contained in Aktiebolaget Volvo v. Federal Commissioner of Taxation (1978) 8 ATR 747; 78 ATC 4316, where instead of amounts being payable for the exclusive right to use the property they were made for the undertaking that the right to use the property will not be granted to anyone else, not being subject to tax as a royalty payment under the terms of Article 12. [Sub-paragraph 3(h)]

Other royalties effectively treated as business profits

3.96       As in the case of interest income, it is specified that the 10% tax rate limitation is not to apply to royalties effectively connected with a ‘permanent establishment’ or ‘fixed base’ in the country in which the income is sourced - such income being subject to full taxation under either Article 7 or Article 14 as the case may be. [Paragraph 4]

Deemed source rule

3.97       The royalties source rule provided for in the DTA effectively corresponds in the case of Australia with the deemed source rule contained in section 6C (Source of Royalty income derived by a nonresident) of the ITAA 1936 for royalties paid to nonresidents of Australia. It broadly mirrors the source rule for interest income contained in paragraph 5 of Article 11 ( Interest ). [Paragraph 5]

Related persons

3.98       If royalties flow between the payer and the person beneficially entitled to the royalties as the result of a special relationship between them, the 10% source country tax rate limitation will apply only to the extent that the royalties are not excessive. Any excess part of the royalty remains taxable according to the domestic law of each country but subject to the other articles of this DTA.

3.99       A special relationship is generally taken to exist where royalties are paid to an individual by an associate or legal person who is directly or indirectly controlled by an individual or associated legal person or to a subordinate, or a group having a common interest with them. It covers those relationships that exist by way of blood or marriage and in general any community of interest. [Paragraph 6]

Article 13 - Alienation of property

Taxing rights

3.100     This article allocates between the respective countries taxing rights in relation to income, profits or gains arising from the alienation of real (immovable) property (as defined in Article 6) and other items of property.

Real property

3.101     Income, profits or gains from the alienation of real property may be taxed by the country in which the property is situated. [Paragraph 1]

3.102     The reference to ‘income, profits or gains’ is designed to put beyond doubt that a gain from the alienation of property which in Australia is income or a profit under ordinary concepts, will be subject to tax in accordance with this article, rather than the Business profits article (Article 7), together with relevant capital gains.

Permanent establishment

3.103     Paragraph 2 deals with income, profits or gains arising from the alienation of property (other than real property covered by paragraph 1) forming part of the business assets of a ‘permanent establishment’ of an enterprise or pertaining to a ‘fixed base’ used for performing independent personal services. It also applies where the ‘permanent establishment’ itself (alone or with the whole enterprise) or the fixed base is alienated. Such income or gains may be taxed in the country in which the ‘permanent establishment’ or ‘fixed base’ is situated. This corresponds to the rules for business profits and for income from independent personal services contained in Articles 7 and 14 respectively. [Paragraph 2]

Disposal of ships or aircraft

3.104     Income, profits or gains from the disposal of ships or aircraft operated in international traffic, or associated property (other than real property covered by paragraph 1) are taxable only in the country of residence of the operator of the ships or aircraft. This rule corresponds to the operation of Article 8 in relation to profits from the operation of ships or aircraft in international traffic. [Paragraph 3]

Shares and other interests in land-rich entities

3.105     Paragraph 4 extends the coverage of this article to situations involving the alienation of shares or other interests in companies, and other entities, whose assets consist principally of real property (as defined in Article 6) which is situated in the other country (again, in the terms of Article 6). Such income or gains may thus be taxed by the country in which the real property is situated. This paragraph complements paragraph 1 of this article and is designed to cover arrangements involving the effective alienation of incorporated real property, or like arrangements.

3.106     This is to be the case whether the real property is held directly or indirectly through a chain of interposed entities. While not limited to chains of companies, or even chains of entities only some of which are companies, the example of chains of companies is used to make clear that the corporate veil should be lifted in examining direct or indirect ownership.

3.107     This provision responds to the tax planning opportunities exposed by the decision of the Full Federal Court in the Commissioner of Taxation v. Lamesa Holdings BV (1997) 77 FCR 597. It is designed to protect Australian taxing rights over income, profits or gains on the alienation or effective alienation of Australian real property (as defined) despite the presence of interposed bodies corporate or other entities. [Paragraph 4]

Capital gains

3.108     The article contains a sweep-up provision in relation to capital gains which enables each country to tax, according to its domestic law, any gains of a capital nature derived by its own residents or by a resident of the other country from the alienation of any property not specified in the preceding paragraphs of the article. It thus preserves the application of Australia’s domestic law relating to the taxation of capital gains in relation to the alienation of such property. [Paragraph 5]

Definition of real property

3.109     The term real property is to be defined for the purposes of this article as it is under Article 6. Where the property is situated is determined in accordance with paragraph 3 of Article 6. [Paragraphs 6 and 7]

Business profits

3.110     As indicated earlier, income, profits or gains from the alienation of property that fall within the scope of this article are not affected by the ‘business profits’ provisions of Article 7. In the event that the operation of this article should result in an item of income or gain being subjected to tax in both countries, the country in which the person deriving the income or gain is a resident (as determined in accordance with Article 4) would be obliged by Article 22 ( Source of income ) and Article 23 ( Methods of elimination of double taxation ) to provide double tax relief for the tax imposed by the other country.

Article 14 - Independent personal services

Taxing rights

3.111     Under this article income derived by an individual in respect of professional services or other independent activities will be subject to tax in the country in which the services or activities are performed if the recipient has a ‘fixed base’ regularly available in that other country for the purposes of performing his or her activities.

3.112     If this condition is met, the country in which the services or activities are performed will be able to tax so much of the income as is attributable to the activities exercised from that ‘fixed base’. [Paragraph 1]

3.113     If the above test is not met, the income will be taxed only on the country of residence of the recipient.

3.114     Remuneration derived as an employee and income derived by public entertainers are the subject of other articles of the DTA and are not covered by this article.

Article 15 - Dependent personal services

Basis of taxation

3.115     This article generally provides the basis upon which the remuneration of visiting employees is to be taxed. The provisions of this article do not apply, however, in respect of income that is dealt with separately in:

·          Article 16 ( Directors’ fees );

·          Article 18 ( Pensions and annuities ); and

·          Article 19 ( Government service )

of the DTA.

3.116     Generally, salaries, wages and similar remuneration derived by a resident of one country from an employment exercised in the other country will be liable to tax in that other country. However, subject to specified conditions, there is a conventional provision for exemption from tax in the country being visited where visits of only a short-term nature are involved. [Paragraph 1]

Short-term visit exemption

3.117     The conditions for this exemption are that:

·          the visit or visits does not exceed, in the aggregate, 183 days in any 12 month period commencing or ending in the year of income or year of assessment concerned of the visited country; and

·          the remuneration is paid by, or on behalf of, an employer who is not a resident of the country being visited; and

·          the remuneration is not deductible in determining taxable profits of a ‘permanent establishment’ or a ‘fixed base’ which the employer has in the country being visited; and

·          the remuneration is subject to tax in the country in which the recipient is resident.

3.118     Where all of these conditions are met, the remuneration so derived will be liable to tax only in the country of residence of the recipient. [Paragraph 2]

3.119     Where a short-term visit exemption is not applicable, remuneration derived by a resident of Australia from employment in the Slovak Republic may be taxable in the Slovak Republic. However, the article does not allocate sole taxing rights to the Slovak Republic in that situation.

3.120     Accordingly, Australia would also be entitled to tax that remuneration in accordance with the general rule of the Income Tax Assessment Act 1997 (ITAA 1997) that a resident of Australia remains subject to tax on worldwide income. In common, however, with other situations where the DTA allows both countries to tax a category of income, Australia would be required in this situation (pursuant to Article 23), as the country in which the income recipient is resident for tax purposes, to relieve the double taxation that would otherwise occur.

3.121     Although that article provides for the double tax relief to be provided by Australia to be in the form of the grant of a credit against the Australian tax for the Slovak tax paid, the exemption with progression method of providing double tax relief in relation to employment income derived in the situation described would normally be applicable in practice pursuant to the foreign service income provisions of section 23AG of the ITAA 1936. This method takes into account the foreign earnings when calculating the Australian tax on other assessable income the person has derived.

Employment on a ship or aircraft

3.122     Income from an employment exercised aboard a ship or aircraft operated in international traffic may be taxed in the country of residence of the operator. [Paragraph 3]

Article 16 - Directors’ fees

3.123     Under this article, remuneration derived by a resident of one country in the capacity of a director of a company which is a resident of the other country may be taxed in the latter country.

Article 17 - Entertainers and sportspersons

Personal activities

3.124     By this article, income derived by visiting entertainers (which has a reasonably wide meaning in international tax treaty usage) and sportspersons from their personal activities as such may generally be taxed in the country in which the activities are exercised, irrespective of the duration of the visit. The words ‘income derived by entertainers...from their personal activities as such...’ extend the application of this article to income generated from promotional and associated kinds of activities engaged in by the entertainer or sportsperson while present in the visited country. [Paragraph 1]

Safeguard

3.125     There is a safeguard provision included in this article which is designed to ensure that income in respect of personal activities exercised by an entertainer or sportsperson, whether received:

·          by the entertainer or sportsperson; or

·          by another person, for example, a separate enterprise which formally provides the entertainer’s or sportsperson’s services,

is taxed in the country in which the entertainer or sportsperson performs, whether or not that other person has a ‘permanent establishment’ or ‘fixed base’ in that country. [Paragraph 2]

Article 18 - Pensions and annuities

3.126     Pensions and annuities (the term ‘annuity’ as used in this article is defined in paragraph 2) are taxable only by the country in which the recipient is resident. The article extends to government pensions, and pension and annuity payments made to dependants, for example a widow, widower, or children, of the person in respect of whom the pension or annuity entitlement accrued where, upon that person’s death, such entitlement has passed to that person’s dependants. [Paragraphs 1 and 2]

Alimony and maintenance payments

3.127     The taxing right in respect of alimony and other maintenance payments is allocated solely to the country of residence of the payer, not the recipient. The purpose of this paragraph is to remove any possibility of double taxation of such payments arising by reason of the treatment accorded such payments under the respective domestic laws. In Australia, those payments will generally be exempt from tax in the hands of the recipient and non-deductible to the payer. [Paragraph 3]

Article 19 - Government service

Salary and wage income

3.128     Salary and wage type income, other than government service pensions or annuities, paid to an individual for services rendered to a government (including a State or local authority) of one of the countries, is to be taxed only in that country. However, such remuneration will be taxable only in the other country if:

·          the services are rendered in that other country; and

·          the recipient is a resident of that other country for the purposes of that country’s tax, who is either:

-           a citizen or national of that country; or,

-           did not become a resident of that other country solely for the purpose of rendering the services.

[Paragraph 1]

Trade or business income

3.129     Remuneration for services rendered in connection with a trade or business carried on by any governmental authority referred to in paragraph 1 of the article is excluded from the scope of this article. Such remuneration will remain subject to the provisions of Article 15 ( Dependent personal services ) or Article 16 ( Directors’ fees ) as the case may be, as with any other trade or business. [Paragraph 2]

Article 20 - Students and trainees

Exemption from tax

3.130     This article applies to students and trainees temporarily present in one of the countries solely for the purpose of their education or training if the students are, or immediately before the visit were, resident in the other country. In these circumstances, payments from abroad received by the students or trainees solely for their maintenance, education or training will be exempt from tax in the country visited, even though they may qualify as a resident of the country visited during the period of their visit, and therefore might be taxable but for this article.

3.131     The exemption from tax provided by the visited country is treated as extending to maintenance payments received by the student that are made for maintenance of dependent family members who have accompanied the student to the visited country.

Employment income

3.132     Where however, a student or trainee from the Slovak Republic who is visiting Australia solely for educational purposes undertakes:

·          some part time work with a local employer; or

·          during a semester break undertakes work with a local employer;

the income earned by that student or trainee as a consequence of that employment may, as provided for in Article 15, be subject to tax in Australia. In this situation the payments received from abroad for the student or trainee’s maintenance or education will not however be taken into account in determining the tax payable on the employment income that is subject to tax in Australia. No Australian tax would be payable on the employment income, however, if the student qualifies as a resident of Australia during the visit and the taxable income of the student does not exceed the tax-free threshold applicable to residents.

Article 21 - Income not expressly mentioned

Allocation of taxing rights

3.133     This article provides rules for the allocation between the 2 countries of taxing rights to items of income not expressly mentioned in the preceding articles of the DTA. The scope of the article is not confined to such items of income arising in one of the countries - it extends also to income from sources in a third country.

3.134     Broadly, such income derived by a resident of one country is to be taxed only in his or her country of residence unless it is derived from sources in the other country, in which case the income may also be taxed in the other country. Where this occurs, the country of residence of the recipient of the income would be obliged by Article 23 ( Methods of elimination of double taxation ) to provide double taxation relief. [Paragraphs 1 and 2]

3.135     This article does not apply to income (other than income from real property as defined in Article 6(2)) where the right or property in respect of which the income is paid is effectively connected with a ‘permanent establishment’ or ‘fixed base’ which a resident of one country has in the other country. In such a case, Article 7 ( Business profits ) or Article 14 ( Independent personal services ), as the case may be, will apply. [Paragraph 3]

Article 22 - Source of income

Deemed source

3.136     Sub-paragraph 1 of this article deems income, profits or gains derived by a resident of the Slovak Republic which, under the DTA, may be taxed in Australia to have a source in Australia for the purposes of Australia’s domestic income tax law. It therefore avoids any difficulties arising under domestic law source rules in respect of the exercise by Australia of the taxing rights allocated to Australia by the DTA over income derived by residents of the Slovak Republic. [Paragraph 1]

Double taxation relief

3.137     Sub-paragraph 2 deems income, profits or gains derived by an Australian resident which may be taxed in the Slovak Republic under the DTA to have a source in the Slovak Republic for the purposes of Australian domestic law and Article 23 of the DTA ( Methods of elimination of double taxation ). In this way, income derived by a resident of Australia, which is taxable by both Australia and the Slovak Republic under the DTA, will qualify for double taxation relief to be given by Australia because it will be treated as foreign income for the purposes of:

·          Article 23 ( Methods of elimination of double taxation ) and

·          the ITAA 1936, including the foreign tax credit provisions of that Act.

[Paragraph 2]

3.138     The article does not apply for Slovak tax purposes because the Slovak law contains provisions which enable it to give effect to the DTA without the need for such provisions in the DTA.

Article 23 - Methods of elimination of double taxation

3.139     Double taxation does not arise in respect of income flowing between the 2 countries where the terms of the DTA provide either:

·          for the income to be taxed only in one or other of the countries; or

·          where the domestic taxation law of one of the countries exempts the income from its tax.

Tax credit

3.140     It is necessary, however, to prescribe a method for relieving double taxation for other classes of income which, under the terms of the DTA, remain subject to tax in both countries. This article therefore requires Australia to allow Australian residents a credit against their Australian tax liability for Slovak tax paid in accordance with the DTA on income derived from Slovak sources which is taxable in Australia. [Paragraph 1]

3.141     Where a dividend is paid by a Slovak resident company to an Australian resident company which controls 10% or more of the voting power in the Slovak company, the article requires Australia to allow a credit for the underlying Slovak tax paid by the company (i.e. the tax paid on the portion of its profits out of which the dividend is paid). This credit is in addition to any credit allowable for the Slovak tax paid in respect of the dividends themselves. [Paragraph 2]

3.142     Australia’s general foreign tax credit system, together with the terms of this article and of the DTA generally, will form the basis of Australia’s arrangements for relieving a resident of Australia from double taxation on income arising from sources in the Slovak Republic. As in the case of Australia’s other DTAs, the source of income rules specified by Article 22 for the purposes of the DTA will also apply for those purposes.

3.143     Accordingly, effect is to be given to the tax credit relief obligation imposed on Australia by paragraphs 1 and 2 of this article by application of the general foreign tax credit provisions (Division 18 of Part III) of the ITAA 1936. This will include the allowance of underlying tax credit relief in respect of dividends paid by Slovak resident companies that are related to Australian resident companies, including for unlimited tiers of related companies, in accordance with the relevant provisions of the ITAA 1936 and the ITAA 1997.

3.144     In the case of a resident of the Slovak Republic who is taxable in that country on income which is taxable in Australia under the DTA, the article requires the Slovak Republic to allow the Slovak resident a deduction for the amount of Australian tax paid on that income. However, the amount of deduction allowable is limited to a maximum of the amount of Slovak tax payable on the income derived from Australian sources. [Paragraph 3]

Article 24 - Mutual agreement procedure

Consultation

3.145     One of the purposes of this article is to provide for consultation between the competent authorities of the 2 countries with a view to reaching a satisfactory solution where a person is able to demonstrate actual or potential imposition of taxation contrary to the provisions of the DTA.

3.146     A person wishing to use this procedure must present a case to the competent authority of the country of which the person is a resident within 4 years of the first notification of the action which the taxpayer considers gives rise to taxation not in accordance with the DTA. [Paragraph 1]

3.147     If, on consideration by the competent authorities, a solution is reached, it may be implemented irrespective of any time limits imposed by the domestic tax law of the relevant country. [Paragraph 2]

Resolution of difficulties

3.148     The article also authorises consultation between the competent authorities of the 2 countries for the purpose of resolving any difficulties regarding the interpretation or application of the DTA and to give effect to it. [Paragraphs 3 and 4]

Article 25 - Exchange of information

Limitations on exchange

3.149     This article authorises and limits the exchange of information by the 2 competent authorities to information necessary for the carrying out of the DTA or for the administration of domestic laws concerning the taxes to which the DTA applies. [Paragraph 1]

3.150     The limitation placed on the kind of information authorised to be exchanged means that information access requests relating to taxes not within the coverage provided by Article 2 ( Taxes covered ), for example, sales tax, are not within the scope of the article.

Purpose

3.151     The purposes for which the exchanged information may be used and the persons to whom it may be disclosed are restricted consistently with Australia’s other DTAs. Any information received by a country shall be treated as secret in the same manner as information obtained under the domestic law of that country. [Paragraph 1]

3.152     An exchange of information that would disclose any trade, business, industrial, commercial or professional secret or trade process or which would be contrary to public policy is not permitted by the article. [Paragraph 2]

Article 26 - Diplomatic and consular officials

3.153     The purpose of this article is to ensure that the provisions of the DTA do not result in members of diplomatic and consular posts receiving less favourable treatment than that to which they are entitled in accordance with international conventions. Such persons are entitled, for example, to certain fiscal privileges under the Diplomatic (Privileges and Immunities) Act 1967 and the Consular (Privileges and Immunities) Act 1972 which reflect Australia’s international diplomatic and consular obligations.

Article 27 - Entry into force

Date of entry into force

3.154     This article provides for the entry into force of the DTA. This will be on the last date on which notes are exchanged notifying that the last of the domestic processes to give the DTA the force of law in the respective countries has been completed. In Australia, enactment of the legislation giving the force of law in Australia to the DTA along with tabling the treaty in Parliament are prerequisites to the exchange of diplomatic notes.

Date of application for Australian withholding taxes

3.155     Once it enters into force, the DTA will apply in Australia to withholding taxes in respect of income derived on or after 1 January in the calendar year next following that in which the DTA enters into force.

Date of application for other Australian taxes

3.156     In Australia the DTA will first apply to other Australian taxes on income, profits or gains of the Australian year of income beginning on or after 1 July in the calendar year next following the calendar year in which the DTA enters into force.

Substituted accounting periods

3.157     Where a taxpayer has adopted an accounting period ending on a date other than 30 June, the accounting period that has been substituted for the year of income beginning on 1 July of the calendar year next following that in which the DTA enters into force will be the relevant year of income for the purposes of the application of ‘other Australian tax’.

Date of application in the Slovak Republic

3.158     In the Slovak Republic, the DTA will first apply to Slovak tax withheld at source on or after 1 January in the calendar year next following the calendar year in which the DTA enters into force. For other Slovak tax, it will first apply in relation to tax chargeable for the taxable year beginning on that 1 January. [Paragraph 2]

Article 28 - Termination

3.159     The DTA is to continue in effect indefinitely. However, either country may give written notice of termination of the DTA through the diplomatic channel on or before 30 June in any calendar year beginning 5 years after the date the DTA entered into force.

Cessation in Australia

3.160     In the event of either country terminating the DTA, the DTA would cease to be effective in Australia for the purposes of withholding tax in respect of income derived by a nonresident on or after 1 January in the calendar year next following the year in which the notice of termination is given.

3.161     For other Australian tax, it would cease to be effective in relation to income, profits or gains of any year of income beginning on or after 1 July in the calendar year next following that in which the notice of termination is given.

Cessation in the Slovak Republic

3.162     The DTA would cease to be in force for the purposes of withholding tax in relation to amounts derived on or after 1 January in the calendar year subsequent to that in which the notice of termination is given. In relation to other Slovak tax the notice of termination would take effect in relation to tax chargeable for any taxable year beginning on or after 1 January in the calendar year next following that in which the notice of termination is given.

 



C hapter

Agreement with the Argentine Republic

Main features of the Argentine Agreement

4.1         The agreement between Australia and Argentina accords substantially with Australia’s recent comprehensive double taxation agreements (DTAs). However a number of modifications to the usual provisions have been required to accommodate Argentina’s tax treaty practices, some of which are included in a Protocol to the DTA.

4.2         The features of the DTA and Protocol include:

·          Dual residents individuals (i.e. persons who are residents of both Australia and Argentina according to the domestic law of each country) are, in accordance with specified criteria, to be treated for the purposes of the DTA as being residents of only one country.

·          Income from real (immovable) property may be taxed in full by the country in which the property is situated. Income from real property for these purposes includes natural resource royalties.

·          Business profits are to be generally taxed only in the country of residence of the recipient unless they are derived by a resident of one country through a branch or other prescribed ‘permanent establishment’ in the other country, in which case that other country may tax the profits. Profits from sales of similar goods and merchandise not through a ‘permanent establishment’ may in certain circumstances also attract ‘permanent establishment’ country taxation.

·          The furnishing of services, including consultancy or managerial services by a resident of one country will constitute a ‘permanent establishment’ in the other country where such activities are performed in the other country during a period of more than 183 days in a 12 month period.

·          Subject to a 10% limitation, provision is made for either country to impose a branch profits tax on the ‘after tax’ amount of the profits of a ‘permanent establishment’.

·          Profits from international operations of ships and aircraft may be taxed only in the country of residence of the operator.

·          Profits of associated enterprises may be taxed on the basis of dealings at arm’s length.

·          Dividends, interest and royalties may generally be taxed in both countries, but there are limits on the tax that the country in which the dividend, interest or royalty is sourced may charge on such income flowing to residents of the other country who are beneficially entitled to that income. These limits are 12% for interest, and 10 or 15% for royalties, depending on the nature of the royalties.

-           In Australia , where a franked dividend is paid to a person that holds directly at least 10% of the voting power of the company paying the dividend, Australia may tax up to 10% of the dividend payment. A 15% limitation applies to other dividends in both countries.

-           In Argentina , a 10% limit applies where dividends are paid to a person who holds at least 25% of the capital of the paying company.

·          Income, profits or gains from the alienation of real property may be taxed in full by the country in which the property is situated. Subject to that rule and other specific rules in relation to business assets and some shares, capital gains are to be taxed in accordance with the domestic law of each country.

·          Income from professional services and other similar activities provided by an individual will generally be taxed only in the country of residence of the recipient. However, remuneration derived by a resident of one country in respect of professional services rendered in the other country may, where that remuneration is derived through a ‘fixed base’ of the person concerned in that country or if the person is present for more than 183 days in any 12 month period in that country.

·          Income from dependent personal services, that is, employee’s remuneration, will generally be taxable in the country where the services are performed. However, where the services are performed during certain short visits to one country by a resident of the other country, the income will generally be exempt in the country visited.

·          Directors’ fees and similar payments may be taxed in the country of residence of the paying company.

·          Income derived by entertainers may generally be taxed by the country in which the activities are performed. Specific provision is made for country sponsored cultural entertainment.

·          Pensions and annuities may be taxed only in the country of residence of the recipient.

·          Government service remuneration will generally be taxed only in that country. However, the remuneration may be taxed in the other country in certain circumstances where the services are rendered in that other country.

·          Remuneration of visiting professors and teachers received for teaching, study or research will generally be exempt from tax in the country visited so long as the period of the visit does not exceed 2 years.

·          Income of visiting students will be exempt from tax in the country visited insofar as it consists of payments made from abroad for the purposes of their maintenance or education.

·          Other income (i.e. income not dealt with by other articles) may be generally taxed in both countries, with the country of residence of the recipient providing double tax relief.

·          Double taxation relief for income which under the DTA may be taxed by both countries is to provided by the country of residence of the recipient as follows:

-           in Australia , by allowing a credit for the Argentine tax paid in accordance with the DTA against Australian tax payable on the income derived by a resident of Australia from sources in Argentina.

-           in Argentina, by allowing a credit for Australian tax paid in accordance with the DTA, against any Argentine tax on that income.

·          In the case of Australia, effect will be given to the double tax relief obligations arising under the DTA by application of the general foreign tax credit system provisions of Australia’s domestic law, or relevant exemption provisions of that law where applicable.

·          Provision is made for tax sparing relief to be provided by Australia in respect of certain business activities subject to concessional tax treatment by Argentina for development purposes if at a future time the 2 Governments exchange diplomatic notes for that purpose.

·          Consultation and exchange of information and between the 2 taxation authorities is authorised by the DTA.

Agreement between Australia and the Argentine Republic

Article 1 - Persons covered

Scope

4.3         This article establishes the scope of application of the DTA, by providing for it to apply to persons (defined to include companies) who are residents of one or both countries. It generally precludes extra-territorial application of the DTA.

4.4         The application of the DTA to persons who are dual residents (i.e. residents of both countries) is dealt with in Article 4.

Article 2 - Taxes covered

Taxes covered

4.5         This article specifies the existing taxes of each country to which the DTA applies. These are, in the case of Australia:

·          the Australian income tax; and

·          the resource rent tax in respect of offshore petroleum projects.

4.6         It is specifically stated that the article applies only to taxes imposed under the federal law of Australia. This is to ensure that the DTA does not bind Australian States and Territories and applies only to federal taxes.

4.7         For Argentina the DTA applies to the income tax ( impuesto a las ganancias ).

4.8         In the case of Australia, income tax (including that imposed on capital gains) and resource rent tax are covered by the DTA. Sales tax, goods and services tax, fringe benefits tax, wool tax and levies, customs duties, State tax and duties and estate tax and duties are not covered by the DTA.

Substantially similar taxes

4.9         The application of the DTA will be automatically extended to any identical or substantially similar taxes which are subsequently imposed by either country in addition to, or in place of, the existing taxes. A duty is imposed on Australia and Argentina to notify each other within a reasonable time of any significant changes to their respective laws to which the DTA applies.

Article 3 - General definitions

Definition of Australia

4.10       As with Australia’s other modern taxation agreements, Australia , when used in a geographical sense, is defined to include certain external territories and areas of the continental shelf. This definition preserves Australia’s taxing rights over mineral exploration and mining activities carried on by nonresidents on the seabed and subsoil of the relevant continental shelf areas.

4.11       The definition of Australia includes the 12 nautical mile territorial sea, the contiguous zone for purposes consistent with international law, and the continental shelf and exclusive economic zone of Australia in relation to exploration for and exploitation of the living and non-living natural resources, and tourism or recreation on offshore installations.

Definition of company

4.12       The definition of company in the DTA accords with Australia’s DTA practice. It reflects the fact that Australia’s domestic tax law does not specifically use the expression body corporate for tax purposes.

4.13       The Australian tax law treats certain trusts (public unit trusts and public trading trusts) and corporate limited partnerships as companies for income tax purposes. These entities will be regarded as companies for the purposes of the DTA. [Sub-paragraph 1(e)]

Definition of international traffic

4.14       This term is of relevance only for alienation of ships and aircraft used in such traffic (Article 13.4) and wages of crew (Article 15.3). [Sub-paragraph 1(i)]

Definition of tax

4.15       For the purposes of the DTA, the term tax does not include any amount of penalty or interest imposed under the respective domestic law of the 2 countries. This is important in determining a taxpayer’s entitlement to a foreign tax credit under the double tax relief provisions of Article 24 of the DTA. [Sub-paragraph 1(k)]

4.16       In the case of a resident of Australia, any penalty or interest component of a liability determined under the domestic taxation law of Argentina with respect to income that Argentina is entitled to tax under the DTA, would not be a creditable tax for the purposes of Article 24.1 of the DTA. This is in keeping with the meaning of foreign tax in the Income Tax Assessment Act 1936 (ITAA 1936) (subsection 6AB(2) - Foreign Income and Foreign Tax). Accordingly, such a penalty or interest liability would be excluded from calculations when determining the Australian resident taxpayer’s foreign tax credit entitlement under Article 24.1 (pursuant to Division 18 of Part III of the ITAA 1936 - Credits in Respect of Foreign Tax).

Terms not specifically defined

4.17       Where a term is not specifically defined within this DTA, that term (unless used in a context that requires otherwise) is to be taken to have the same interpretative meaning as it has under the domestic law of the country applying the DTA at the time of its application, with the meaning it has under the taxation law of the country having precedence over the meaning it may have under other domestic laws.

4.18       If a term is not defined in the DTA, but has an internationally understood meaning in double tax treaties and a meaning under the domestic law the context would normally require that the international meaning be applied. [Paragraph 2]

Article 4 - Residence

Residential status

4.19       This article sets out the basis by which the residential status of a person is to be determined for the purposes of the DTA. Residential status is one of the criteria for determining each country’s taxing rights and is a necessary condition for the provision of relief under the DTA. The concept of who is a resident according to each country’s taxation law provides the basic test. [Paragraph 1]

4.20       A person is not a resident of Australia for the purposes of the DTA if that person is liable to tax in Australia in respect only of income from sources in Australia. The provision means, for example, that Norfolk Island residents, who are generally subject to Australian tax on Australian source income only, will not be residents of Australia for the purposes of the DTA. Accordingly, Argentina will not have to forgo tax in accordance with the DTA on income derived by residents of Norfolk Island from sources in Argentina (which will not be subject to Australian tax). [Paragraph 2]

Dual residents

4.21       The article also includes a set of tie-breaker rules for determining how residency is to be allocated to one or other of the countries for the purposes of the DTA if a taxpayer - whether an individual, company or other entity - qualifies as a dual resident, that is, as a resident under the domestic law of both countries.

4.22       The tie-breaker rules for individuals applies certain tests, in a descending hierarchy, for determining the residential status (for the purposes of the DTA) of an individual who is a resident of both countries under their respective domestic laws.

4.23       These rules, in order of application are:

·          if the individual has a permanent home in only one of the countries, the person is deemed to be a resident only of that country for the purposes of the DTA;

·          if the individual has a permanent home available in both countries or in neither, then their residential status takes into account the person’s personal or economic relations (including the person’s habitual abode) with Australia and Argentina, and the person is deemed to be a resident only of the country for the purposes of the DTA with which they have the closer personal and economic relations.

[Paragraph 3]

4.24       In circumstances where the dual resident is a company the DTA provides that, for the purposes of the DTA, the company will be deemed to be a resident for the purposes of the DTA only of the country in which its place of effective management is situated. [Paragraph 4]

Article 5 - Permanent establishment

Role and definition

4.25       Application of various provisions of the DTA (principally Article 7 relating to business profits) is dependent upon whether a person who is a resident of one country has a ‘permanent establishment’ in the other, and if so, whether income derived by the person in the other country is attributable or effectively connected with carrying on a business through that ‘permanent establishment’. The definition of the term ‘permanent establishment’ which this article embodies, corresponds generally with definitions of the term in Australia’s more recent DTAs.

Meaning of ‘permanent establishment’

4.26       The primary meaning of the term ‘permanent establishment’ is expressed as being a fixed place of business through which the business of an enterprise is wholly or partly carried on. A ‘permanent establishment’ must comply with the following requirements:

·          there must be a place of business; and

·          the place of business must be fixed (both in terms of physical location and in terms of time); and

·          the business of the enterprise must be carried on through this fixed place.

[Paragraph 1]

4.27       Other paragraphs of the article are concerned with elaborating on the meaning of the term by giving examples (by no means intended to be exhaustive) of what may constitute a ‘permanent establishment’, such as:

·          an office;

·          a workshop; or

·          a mine.

As paragraph 2 is subordinate to paragraph 1, the examples listed will only constitute a ‘permanent establishment’ if the primary definition in paragraph 1 is satisfied. [Paragraph 2]

Agricultural, pastoral or forestry activities

4.28       All of Australia’s comprehensive DTAs include as a ‘permanent establishment’ an agricultural, pastoral or forestry property. This reflects Australia’s policy of retaining taxing rights over exploitation of Australian land for the purposes of primary production. This approach ensures that the arm’s length profits test provided for in Article 7 (Business profits) applies to the determination of profits derived from these activities. This position is also reflected in this DTA. [Sub-paragraph 2(g)]

Building sites or construction, installation or assembly projects

4.29       Also consistent with Australia’s DTA practice, sub-paragraph 2(h) of the DTA includes building sites or construction, installation or assembly projects which exist for more than 6 months as examples of a ‘permanent establishment’. Building sites, construction, installation and assembly projects lasting less than 6 months, which nevertheless meet the requirements of other ‘permanent establishment’ rules will be ‘permanent establishments’.

4.30       The term a building site or construction, installation or assembly project covers constructional activities such as excavating or dredging. The term ‘building site’ can only mean such work as is directly connected with the erection of buildings and similar projects (earth work, masonry, painting, roofing, glazing and plumbing). Planning and supervision are certainly part of the building site if carried out by the construction contractor. However, planning and supervision of work does not represent a building site if carried out by another enterprise (see paragraph 4.35 regarding sub-paragraph 4(a) of Article 5). [Sub-paragraph 2(h)]

Preparatory and auxiliary activities

4.31       Certain activities are deemed not to give rise to a permanent establishment, for example, use of facilities or maintenance of a stock of goods solely for storage, or display, or other preparatory or auxiliary activities.

4.32       Generally activities of a preparatory or auxiliary character are unlikely to give rise to substantial profits. The necessary economic link between the activities of the enterprise and the country in which the activities are carried on does not exist in these circumstances.

4.33       Unlike the OECD Model Tax Convention on Income and on Capital (the OECD Model), which provides that the listed activities are deemed not to constitute a ‘permanent establishment’, the DTA incorporates the Australian DTA approach of stating that an enterprise will not be deemed to have a ‘permanent establishment’ merely by reason of such activities. This is to prevent the situation where enterprises structure their business so that most their activities fall within the exceptions when - viewed as a whole - the activities ought to be regarded as a ‘permanent establishment’.

4.34       Another feature consistent with Australia’s DTA practice is that sub-paragraph 4(f) of the OECD Model - dealing with combinations of the activities in sub-paragraphs (a) to (e) - is not included. Australia does not consider that an enterprise undertaking multiple functions of the kind indicated in sub-paragraphs (a) to (e) could reasonably be regarded as only engaged in preparatory or auxiliary activities. [Paragraph 3]

Deemed permanent establishments

Supervisory activities

4.35       Supervisory activities carried on for more than 6 months in connection with a building site or a construction, installation or assembly project are deemed to constitute a permanent establishment. Australia has a reservation on Article 5 of the OECD Model reflecting this position. The rationale for inclusion of this provision is the prevalence of the use in Australia of imported expertise in relation to supervision of such projects. [Sub-paragraph 4(a)]

The furnishing of services in relation to a project

4.36       The furnishing of services, including consultancy or managerial services, will constitute a permanent establishment where the services are performed (for the same or a connected project) by an enterprise of one country in the other country for a period aggregating more than 183 days in any 12 month period. This provision is consistent with Argentine treaty practice. It reflects Argentine domestic law which taxes payments made by Argentine firms for technical, engineering, or consultancy services that are utilised in Argentina.

4.37       Sub-paragraph 4(b) forms part of the general scheme of the DTA in relation to the taxation of technical services, whereby certain payments for technical assistance are to be subject to limited rates of tax as royalties in accordance with Article 12, while fees paid for other services will remain subject to the rules in Article 7 or Article 14. Paragraphs 4.111 to 4.115 discuss the treatment of technical assistance in relation to Article 12. [Sub-paragraph 4(b)]

Substantial equipment

4.38       Under sub-paragraph 4(c) an enterprise is deemed to have a ‘permanent establishment’ in a State if substantial equipment is being used in that State by, for or under contract with the enterprise.

4.39       This position is reflected in Australia’s reservation to the OECD Model and one effect is to further protect Australia’s right to tax income from natural resources. Australia’s experience is that the ‘permanent establishment’ provision in the OECD Model may be inadequate to deal with high value activities involved in the development of natural resources, particularly in offshore regions.

4.40       Some examples of substantial equipment would include:

·          large industrial earth moving equipment or construction equipment used in road building, dam building or powerhouse construction etc.;

·          manufacturing or processing equipment used in a factory;

·          oil and drilling rigs, platforms and other structures used in the petroleum/mining industry; and

·          grain harvesters and other large agricultural machinery.

4.41       For the purposes of the application of Article 7.1 the enterprise is deemed to carry on business through the substantial equipment permanent establishment. [Sub-paragraph 4(c)]

Dependent agents

4.42       Paragraph 5 reflects Australia’s DTA practice in relation to a person who acts on behalf of an enterprise of another country of deeming that person to constitute a ‘permanent establishment’ if that person has and habitually exercises an authority to conclude contracts on behalf of the enterprise. This will apply unless the agent’s activities are limited to the purchase of goods or merchandise for the enterprise, or the agent is an ‘independent agent’ to whom paragraph 6 applies. [Sub-paragraph 5(a)]

Cost-toll operations

4.43       The inclusion of sub-paragraph 5(b) is consistent with another of Australia’s reservations to the OECD Model. It deals with so-called cost-toll situations, under which, for example, a mineral plant refines minerals at cost, so that the plant operations produce no Australian profits. Title to the refined product remains with the mining consortium and profits on sale are realised mainly outside of Australia.

4.44       Sub-paragraph 5(b) deems such a plant to be a ‘permanent establishment’ because the manufacturing or processing activity (which gives the processed minerals their real value) is conducted in Australia, and therefore Australia should have taxing rights over business profits arising from the sale of the processed minerals to the extent that they are attributable to the processing activity carried on in Australia. This sub-paragraph prevents an enterprise which carries on very substantial manufacturing or processing activities in a country through an intermediary from claiming that it does not have a ‘permanent establishment’ in that country.

4.45       The inclusion of this sub-paragraph is insisted upon by Australia in its DTAs and is consistent with Australia’s policy of retaining taxing rights over exploitation of its mineral resources. [Sub-paragraph 5(b) ]

Independent agents

4.46       Business carried on through an independent agent does not, of itself, constitute a ‘permanent establishment’ provided that the independent agent is acting in the ordinary course of the agent’s business as such an agent. [Paragraph 6]

Subsidiary companies

4.47       Generally a subsidiary company will not be a ‘permanent establishment’ of its parent company. A subsidiary, being a separate legal entity, would not usually be carrying on the business of the parent company but rather its own business activities. However a subsidiary company gives rise to a ‘permanent establishment’ if the subsidiary permits the parent company to operate from its premises such that the tests in paragraph 1 are met, or acts as an agent such that a dependent agent ‘permanent establishment’ is constituted. [Paragraph 7]

Article 6 - Income from real (immovable) property

Where income from real property is taxable

4.48       This article provides that the income of a resident of one country from real property situated in the other country may be taxed by the other country. Thus income from real property in Australia will be subject to Australian tax laws. [Paragraph 1]

Definition

4.49       Income from real property is effectively defined as extending, in the case of Australia and Argentina, to:

·          the direct use, letting or use in any other form of real property, a lease of land and any other interest in or over land (including exploration and mining rights); and

·          royalties and other payments relating to the exploration for or exploitation of mines or quarries or other natural resources or rights in relation thereto.

[Paragraph 2]

Deemed situs

4.50       Under Australian law the situation of an interest in land, such as a lease, is not necessarily where the underlying property is situated - there may not necessarily be a situs. Paragraph 3 puts the situation of the interest or right beyond doubt. [Paragraph 3]

Real property of an enterprise and of persons performing independent personal services

4.51       The operation of this article extends to income derived from the use or exploitation of real property of an enterprise and income derived from real property that is used for the performance of independent personal services.

4.52       Accordingly, application of this article (when read with Articles 7 and 14) to such income ensures that the country in which the real property is situated may impose tax on the income derived from that property by:

·          an enterprise of the other country; or

·          an independent professional person resident in that other country,

irrespective of whether or not that income is attributable to a ‘permanent establishment’ of such an enterprise, or ‘fixed base’ of such a person, situated in the firstmentioned country. [Paragraph 4]

Article 7 - Business profits

4.53       This article is concerned with the taxation of ‘business profits’ derived by an enterprise that is a resident of one country from sources in the other country.

4.54       Under paragraph 1(a), taxation rights over ‘business profits’ depend firstly on whether the profits are attributable to a ‘permanent establishment’ in the other country. If a resident of one country carries on business through a ‘permanent establishment’ (as defined in Article 5) in the other country, the country in which the ‘permanent establishment’ is situated may only tax the profits of the enterprise that are attributable to that ‘permanent establishment’.

4.55       Paragraph 1(a) has 2 main consequences:

·          first, where an enterprise of a country carries on business in the other country, but does not have a ‘permanent establishment’ there, the profits of the enterprise may not be taxed in that other country;

·          secondly, where an enterprise has a ‘permanent establishment’ in the other country, that other country may only tax so much of the profits that are attributable to that ‘permanent establishment’.

Limited force of attraction rule

4.56       Sub-paragraph 1(b) contains a limited force of attraction rule. This rule ensures that where an enterprise carries on business in a country through a ‘permanent establishment’ situated in that other country, sales of similar goods or merchandise, or the carrying on of similar kinds of business activities, which are not conducted through the ‘permanent establishment’ are treated as if they were made through the ‘permanent establishment’. There is an important test in the application of this rule - those sales or activities would not have been made but for the existence of the ‘permanent establishment’ or the continued provision of goods or services by the ‘permanent establishment’. Australia has agreed to similar provisions with a number of developing countries. [Paragraph 1]

Determination of business profits

4.57       Profits of a ‘permanent establishment’ are to be determined for the purposes of the article on the basis of arm’s length dealing. The provisions in the DTA correspond to international practice and the comparable provisions in Australia’s DTAs. [Paragraph 2]

4.58       Paragraph 3 provides that in determining the profits of a ‘permanent establishment’, certain expenses of the enterprise shall be allowed as deductions.

4.59       In accordance with Australian treaty practice, the paragraph further provides that expenses which are not deductible under the domestic law of either country cannot be claimed by the ‘permanent establishment’. Consistently with this (and in accordance with Argentine treaty practice) Protocol Item 1(b)(i) expressly confirms that a country is not required to allow as deductions expenses which are not deductible under the domestic law of the country in determining the profits of a ‘permanent establishment’. [Paragraph 3 and Protocol Item 1(b)(i)]

4.60       Item 1(b)(ii) of the Protocol provides that in determining the profits of a ‘permanent establishment’, no deduction is allowed in respect of certain amounts paid or received by the ‘permanent establishment’ to or from the head office of the enterprise or any other of the branch offices of the enterprise. [Protocol Item 1(b)(ii)]

Mere purchase of goods or merchandise

4.61       No profits are to be attributed to a ‘permanent establishment’ merely because it purchases goods or merchandise for the enterprise. Accordingly, profits of a ‘permanent establishment’ derived from business activities carried on in its own right will not be increased by adding to them any profits attributable to the purchasing activities undertaken for the head office. It follows, of course, that any expenses incurred by the ‘permanent establishment’ in respect of those purchasing activities will not be deductible in determining the taxable profits of the ‘permanent establishment’.

4.62       Item 1(c) of the Protocol reflects Argentine treaty practice and permits domestic law to apply in relation to the export of goods or merchandise purchased by an enterprise. Notwithstanding that sub-paragraph 5(3)(d) deems the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise not to be a permanent establishment, Item 1(c) provides that the export of goods or merchandise purchased by an enterprise remains subject to the domestic legislation concerning export.

4.63       The scope of the Argentine export legislation was recorded in a Memorandum dated 15 November 1994 between officials of both countries as follows:

“3.          With respect to paragraph 1(b) of the draft protocol [ now Protocol Item 1(c) ], it is noted that in accordance with Article 5 of the Argentine Income Tax Law, profits, arising from activities carried out within the territory of the country, are of a domestic source. Likewise, that legislation requires that both in the case of individuals and corporations in order to carry out import or export activities they must register previously in the National Custom’s Office. That registration furthermore requires that they register with the Local Tax Administration, have a domicile in the Argentine Republic and keep accounting records in accordance with specific local regulations.

4.                        It is also understood that Article 8 of the Argentine Income Tax Law stipulates:



a)            that income arising from the export of goods produced or purchased in the country are entirely of Argentine source;



b)            that when the sales price agreed in the case of an export is lower than the wholesale sales price in force in the country of destination, it will be assumed, unless proof is provided to the contrary, that the value of the exported goods is that corresponding to the wholesale price in the country of destination;



c)            that the net income will be established by deducting from said price, the cost of goods, insurance and freight costs to the point of destination, commission and sales expenses and any other expense necessary incurred within the country, in order to determine the income subject to tax.”

[Paragraph 4 and Protocol Item 1(c)]

Inadequate information

4.64       This article allows for the application of the domestic law of the country in which the profits are sourced (e.g. Australia’s Division 13 of the ITAA 1936) where, due to inadequate information, the correct amount of profits attributable on the arm’s length principle basis to a ‘permanent establishment’ cannot be determined or can only be ascertained with extreme difficulty. [Paragraph 5]

Income or gains dealt with under other articles

4.65       Where income or gains are otherwise specifically dealt with under other articles of the DTA the effect of those particular articles is not overridden by this article.

4.66       This provision lays down the general rule of interpretation that categories of income or gains which are the subject of other articles of the DTA (e.g. shipping, dividends, interest, royalties and alienation of property) are to be treated in accordance with the terms of those articles and as outside the scope of this article (except where otherwise provided - e.g. by Article 10.5 where the income is effectively connected to a permanent establishment). [Paragraph 6]

Insurance with nonresidents

4.67       Each country has the right to continue to apply any special provisions in its domestic law relating to the taxation of profits from insurance or reinsurance. However, if the relevant law in force in either country at the date of signature of the DTA is varied (otherwise than in minor respects so as not to affect its general character), the countries shall consult each other with a view to agreeing to any amendment of the paragraph that may be appropriate. An effect of this paragraph is to preserve, in the case of Australia, the application of Division 15 of Part III of the ITAA 1936 (Insurance with Non-residents). [Paragraph 7]

Trust beneficiaries

4.68       The principles of this article will apply to business profits derived by a resident of one of the countries (directly or through one or more interposed trust estates) as a beneficiary of a trust estate.

Example 4.1

In accordance with this article, Australia has the right to tax a share of business profits, originally derived by a trustee of a trust estate (other than a trust estate that is treated as a company for tax purposes) from the carrying on of a business through a ‘permanent establishment’ in Australia, to which a resident of Argentina is beneficially entitled under the trust estate. Paragraph 8 ensures that such business profits will be subject to tax in Australia where, in accordance with the principles set out in Article 5, the trustee of the relevant trust estate has a ‘permanent establishment’ in Australia in relation to that business.

[Paragraph 8]

Branch profits tax

4.69       Item 1(a) of the Protocol authorises the imposition by either of the countries of a branch profits tax at the rate of 10% of the amount by which profits of a company resident in the other country exceeds the tax payable on those profits in the firstmentioned country.

4.70       In the absence of a Non-discrimination article it may not be necessary to include such a provision as the Business profits article itself would generally seem to permit a branch profits tax. However it is Argentine treaty practice to include such a provision and without it Australian companies operating through a ‘permanent establishment’ in Argentina may be exposed to higher rates of any Argentine branch profits tax than enterprises of Argentina’s other treaty partners. [Protocol Item 1(a)]

Article 8 - Ships and aircraft

4.71       The main effect of this article is that the right to tax profits from the operation of ships or aircraft in international traffic, including profits derived from participation in a pool service or other profit sharing arrangement, is generally reserved to the country of residence of the operator. [Paragraphs 1 and 2]

Non transport operations

4.72       However, the article reflects Australian treaty policy to reserve to the other country the right to tax profits from internal traffic, profits from other coastal and continental shelf activities including non transport shipping and aircraft activities within its own waters.

4.73       Thus, the term transport is not used in the title of the article, as the article applies to survey ships, oil drilling ships etc. where transport is not necessarily involved.

4.74       Consistent with Australia’s reservations to Article 8 of the OECD Model and Argentina’s DTA practice, Item 2 of the Protocol explicitly states that the operation of the ships or aircraft referred to in Article 8 includes non transport activities such as dredging, fishing and surveying, and such operations conducted in a place in a country are to be treated as operations confined solely to places in that country. [Protocol Item 2]

4.75       Paragraph 4 provides that interest derived from funds invested in connection with the overseas operation of ships or aircraft, and any other income incidental to such operations, is part of the profits from the operation of the ships or aircraft.

4.76       Most countries accept that the principles contained within paragraph 4 are valid. Argentina considered that express reference to the principles contained in the provision is necessary. Similar provisions are included in Australia’s DTAs with India and Singapore. [Paragraph 4]

4.77       By reason of the definition of Contracting State contained in Article 3 and the terms of paragraph 4 of this article, any shipments by sea or air from a place in Australia (including the continental shelf areas and external territories) for discharge at another place in or for return to that place in Australia, is to be treated as forming part of internal traffic. [Paragraph 5]

Example 4.2

Profits derived from a shipment of goods taken on board (during the course of an international voyage between Buenos Aires and Brisbane) at Melbourne for delivery to Sydney, would be profits from internal traffic. As such, 5% of the amount paid in respect of the internal traffic carriage would be deemed to be taxable income of the operator for Australian tax purposes pursuant to Division 12 of Part III of the ITAA 1936.

Commencement

4.78       Once the DTA enters into force, this article has effect from any year of income beginning on or after 27 September 1988 - reflecting the date of signature of a Memorandum of Understanding concerning air services between Australia and Argentina - see Article 28(a)(iii) ( Entry into force ).

Article 9 - Associated enterprises

Re-allocation of profits

4.79       This article deals with associated enterprises (parent and subsidiary companies and companies under common control). It authorises the re-allocation of profits between related enterprises in Australia and Argentina on an arm’s length basis where the commercial or financial arrangements between the enterprises differ from those that might be expected to operate between independent enterprises dealing wholly at arm’s length with one another.

4.80       The article would not generally authorise the rewriting of accounts of associated enterprises where it can be satisfactorily demonstrated that the transactions between such enterprises have taken place on normal, open market commercial terms. [Paragraph 1]

4.81       Each country retains the right to apply its domestic law relating to the determination of the tax liability of a person (e.g. Australia’s Division 13 of the ITAA 1936) to its own enterprises, provided that such provisions are applied, so far as it is practicable to do so, consistently with the principles of the article. [Paragraph 2]

4.82       Australia’s domestic law provisions relating to international profit shifting arrangements were revised in 1981 in order to deal more comprehensively with arrangements under which profits are shifted out of Australia, whether by transfer pricing or other means. The broad scheme of the revised provisions is to impose arm’s length standards in relation to international dealings, but where the Commissioner of Taxation (the Commissioner) cannot ascertain the arm’s length consideration, it is deemed to be such amount as the Commissioner determines. Paragraph 2 is designed to preserve the application of those domestic law provisions.

Correlative adjustments

4.83       Where a re-allocation of profits is made (either under this article or, by virtue of paragraph 2, under domestic law) so that the profits of an enterprise of one country are adjusted upwards, a form of double taxation would arise if the profits so re-allocated continued to be subject to tax in the hands of an associated enterprise in the other country. To avoid this result, the other country is required to make an appropriate compensatory adjustment to the amount of tax charged on the profits involved to relieve any such double taxation.

4.84       It would generally be necessary for the affected enterprise to apply to the competent authority of the country not initiating the re-allocation of profits for an appropriate compensatory adjustment to reflect the re-allocation of profits made by the other treaty partner country. If necessary, the competent authorities of Australia and Argentina will consult with each other to determine the appropriate adjustment. [Paragraph 3]

Article 10 - Dividends

4.85       This article broadly allows both countries to tax dividends flowing between them but in general limits the rate of tax that the country of source may impose on dividends payable by companies that are residents of that country under its domestic law to beneficial owners resident in the other country. [Paragraphs 1 and 2]

Rate of tax

4.86       Under paragraph 2, the rate of withholding tax which Australia may impose on franked dividends paid to an Argentine person which directly holds at least 10% of the voting power of the company paying the dividends is limited to 10% of the gross amount of the dividends. However, Australia’s domestic law dividend withholding tax exemption for franked dividends paid by Australian companies to nonresident shareholders will continue to apply whilst this remains a feature of the domestic law.

4.87       The DTA further provides that Australia will reduce its rate of withholding tax on unfranked dividends from 30% to 15% of the gross amount of the dividends.

4.88       The rate of withholding tax which Argentina may impose on dividends paid to a person which directly holds at least 25% of capital of the company paying the dividends is limited to 10% of the gross amount of the dividends. In all other cases, the rate of withholding tax which Argentina may impose on dividends is limited to 15% of the gross amount of the dividends.

4.89       The proviso allows for flexibility if there is a change to either country’s general approach to dividend withholding taxes, such as a change to domestic law arrangements for franked dividends flowing overseas. In such a case the 2 countries are obliged to consult to make appropriate amendments to this paragraph. [Paragraphs 2]

Most favoured nation rates of dividend withholding tax

4.90       If after signature of the DTA, Argentina signs a double tax treaty with another OECD member and the rate of source country taxation on dividends, or the level of participation in the capital of an Argentine subsidiary company is less than that specified in the DTA with Australia, Australia and Argentina will consult on lowering the tax rate or participation level. [Protocol Item 5(a)]

Exception to limitation

4.91       The limitation on the tax of the country in which the dividend is sourced does not apply to dividends derived by a resident of the other country who has a ‘permanent establishment’ or ‘fixed base’ in the country from which the dividends are derived, if the holding giving rise to the dividends is effectively connected with that ‘permanent establishment’ or ‘fixed base’.

4.92       Where the dividends are so effectively connected, they are to be treated as ‘business profits’ or income from ‘independent personal services’ and therefore subject to the full rate of tax applicable in the country in which the dividend is sourced (in accordance with the provisions of Article 7 or Article 14, as the case may be). In practice, however, under changes made to Australia’s domestic law with the introduction from 1 July 1987 of a full imputation system of company taxation, such dividends to the extent that they are franked dividends will remain exempt from Australian tax while unfranked dividends will be subject to withholding tax at the rate of 15% instead of being taxed by assessment. [Paragraph 4]

Extra-territorial application

4.93       The extra-territorial application by either country of taxing rights over dividend income is precluded by providing, broadly, that one country (the first country) will not tax dividends paid by a company resident solely in the other country which has derived profits or income from the first country, unless:

·          the person deriving the dividends is a resident of the first country for the purposes of its tax; or

·          the holding giving rise to the dividends is effectively connected with a ‘permanent establishment’ or ‘fixed base’ in the first country.

4.94       However, paragraph 5 does not apply where the dividend paying company is a resident of both Australia and Argentina. This proviso ensures that Australia retains the right to tax dividends paid to a person resident outside of both countries by a company which is a resident of Australia under its domestic law notwithstanding the company is deemed to be a resident of Argentina for the purposes of the DTA pursuant to the tie breaker test contained in Article 4.4. [Paragraph 5]

Article 11 - Interest

Rate of tax

4.95       This article provides for interest income to be taxed by both countries but requires the country of source to generally limit its tax to 12% of the gross amount of the interest where a resident of the other country is the beneficial owner of the interest. This interest withholding tax rate limit is consistent with rates negotiated by Argentina in its tax treaties with other countries. [Paragraphs 1 and 2]

4.96       However, Australia’s general 10% rate of interest withholding tax will continue to be imposed on interest paid to Argentine residents in accordance with Australia’s domestic law.

Exemption for official reserve assets

4.97       Consistently with Australia’s policy on taxation of foreign monetary authorities announced on 5 November 1986, it was agreed to exempt from source country taxation investment of official reserve assets by the governments, government monetary institutions or banks performing central banking functions. [Paragraph 3]

Most favoured nation rates of interest withholding tax

4.98       If after signature of the DTA, Argentina signs a double tax treaty with another OECD member country and the rate of source country taxation on interest is less than that specified in the DTA with Australia, the lower rate will apply from the entry into force of that other DTA. However, the rate will not reduce below Australia’s treaty rate for interest, being 10%. [Protocol Item 6(b)]

Definition of interest

4.99       The term interest is defined for the purposes of the article in a way that, in relation to Australia, encompasses items of income such as discounts on securities and payments under certain hire purchase agreements which are treated for Australian tax purposes as interest or amounts in the nature of interest. This paragraph further provides that the term interest does not include income dealt with in Article 8 ( Ships and aircraft ) or Article 10 ( Dividends ). This specific relationship provision is consistent with Article 8.4 of the DTA and the OECD Model Commentary on Article 10. Similar provisions are included in Australia’s DTAs with India and Ireland. [Paragraph 4]

Interest effectively treated as business profits

4.100     The limitation on the tax of the country in which the interest is sourced does not apply to interest derived by a resident of the other country who has a ‘permanent establishment’ or ‘fixed base’ in the country in which the interest arises, if the indebtedness in respect of which the interest arises is effectively connected with that ‘permanent establishment’ or ‘fixed base’.

4.101     Where the indebtedness is so effectively connected, the interest is to be treated as ‘business profits’ or income from ‘independent personal service’ and therefore subject to the full rate of tax applicable in the country in which the interest is sourced (in accordance with the provisions of Article 7 or Article 14, as the case may be). [Paragraph 5]

Deemed source rules

4.102     Paragraph 6 establishes where interest arises for the purposes of paragraph 1. These rules deem interest to arise in a country and operate, for example, to allow Australia to tax interest to which a resident of Argentina is beneficially entitled where the interest is paid by Australia, or a political subdivision of Australia, or a resident of Australia. Australia may also tax interest paid by a resident of Argentina to which another Argentine resident is beneficially entitled if it is an expense incurred by the payer of the interest in carrying on a business in Australia through a ‘permanent establishment’.

4.103     However, consistent with Australia’s interest withholding tax provisions, an Australian source is not deemed in respect of interest that is an expense incurred by an Australian resident in carrying on a business through a ‘permanent establishment’ outside Australia. [Paragraph 6]

Related persons

4.104     Article 11 also contains a general safeguard against payments of excessive interest where a special relationship exists between the payer of the interest and the person beneficially entitled to the interest. The article restricts the 12% source country tax rate limitation in such cases to an amount of interest which might reasonably have been expected to have been agreed upon by persons dealing at arm’s length . Any excess part of the interest remains taxable according to the domestic law of each country but subject to the other provisions of the DTA. [Paragraph 7]

Article 12 - Royalties

4.105     Article 12 allows both countries to tax royalty flows but generally limits the amount of tax the country in which the royalty arises may impose on the royalty.

Residence country taxation

4.106     Paragraph 1 establishes the field of operation of the article and provides that royalties may be taxed in the country of residence of the person beneficially entitled to the royalty. [Paragraph 1]

Source country taxation

4.107     Paragraph 2 modifies the operation of paragraph 1 and reflects Australia’s reservation to the OECD Model, that is, Australia’s right to tax royalties that have a source in Australia under Australian law.

4.108     Under paragraph 2, the rate of withholding tax to be imposed by the country in which the royalty arises is limited to 10% or 15% of the gross amount of the royalties, depending on the nature of the royalty.

4.109     The withholding tax rate limitation is not to apply to natural resource royalties, which, in accordance with Article 6, are to remain taxable in the country in which they are sourced without limitation on the tax that may be imposed.

4.110     The following chart summarises the various rates of withholding tax agreed in the treaty:

Type of Royalty

Article

Reference

Rate (%) per Article

Number

News

Protocol Item 3(b)

3

Protocol Item 3(b)

Copyright on literary etc. works

12.3(a)

10

12.2(a)

Other copyright and patents, trademarks etc.

12.3(a)

15

12.2(c)

Industrial, scientific equipment

12.3(b)

10

12.2(a)(ii)

Industrial, scientific knowledge

12.3(c)

10

12.2(a)(ii)

Commercial equipment

12.3(i)

15

12.2(c)

Ancillary assistance

12.3(d)

10

12.2(a)(ii)

Other technical assistance

12.3(e)

10 of net

12.2(b)

Satellite reception of visual images or sounds etc.

12.3(f)

15

12.2(c)

TV or radio broadcast of visual images or sounds etc.

12.3(g)

15

12.2(c)

Motion pictures videos etc.

12.3(h)

15

12.2(c)

Forbearance etc.

12.3(a)

10 or 15

12.2(a) & 12.2(c)

Fees for technical services

4.111     Two types of technical services are dealt with under this article - ‘ancillary services’ and ‘other technical assistance services’.

4.112     ‘Ancillary services’ are, broadly, services which are ancillary to other types of royalties (such as copyright and patents) defined in the paragraphs (a), (b) and (c) of the definition of royalty - see Article 12.3(d).

4.113     Argentine domestic tax law currently taxes payments for technical, engineering or consulting services provided from abroad at an effective rate of at least 18% (sometimes up to 30%) of gross payments. These services are treated as royalties in this DTA and to the extent they are not ‘ancillary services’ they are dealt with under Article 12.3(e).

4.114     In addition, technical services effectively connected to a permanent establishment or fixed base are also dealt with in Articles 7 and 14.

4.115     Thus source country taxation rights over technical services are provided in the following ways. Items 4 and 5 in Table 4.1 represent the ‘royalty’ elements of the technical services package.

Table 4.1

Threshold for source country taxation

Extent of source country taxing rights.

1.       Profits attributable to a permanent establishment or fixed base (usual treaty rule).

Unlimited taxing rights over attributable profits. (Articles 7 and 14).

2.       Furnishing of services by an enterprise is deemed to constitute a permanent establishment where the services are performed in either country for more than 183 days in 12 months (Articles 5.4(b) and 7).

Unlimited taxing rights over attributable profits (Article 7).

3.       Similarly, where an individual performs professional or similar services in a country for more than 183 days in 12 months, that country may tax that service income (Article 14.1(b)).

Unlimited taxing rights over attributable income (Article 14).

4.       Ancillary or subsidiary technical services not described above, treated as a royalty (Article 12.3(d)).

10% of gross payments (Article 12.2(a)(ii)).

 

5.       Other technical services not described above, treated as a royalty (Article 12.3(e)).

10% of net payments (Article 12.2(b)).

 

Source of technical assistance

4.116     Under items 4 and 5 above income derived for technical assistance supplied by a resident of one country may be taxed by the other country as royalties even though the assistance may be supplied from the country of residence. The source rules in Article 23 will operate to deem the source of the income to be in the country in which the assistance may be taxed under this article.

Example 4.3

An Argentine resident provides engineering advice to an Australian company on the construction of plant in Australia. The engineer does not visit Australia and the advice is provided electronically. Payment for the advice is a royalty (see Article 12.3(d)). Because under this article the royalty payment may be taxed in Australia, Article 23.1 deems the source of the royalty to be Australia.

If an Australian engineer provided consultancy services to an Argentine company Article 23.2 deems the source of those services to be Argentina for the purposes of Article 24 and Australia’s domestic foreign tax credit rules apply.

Argentine registration requirements

4.117     The reduction in source country taxation of royalties by Argentina is subject to the registration requirements of Argentine law. [Protocol Item 3(a)]

News

4.118     Reflecting Argentine tax treaty policy, payments derived from the transfer of news by an international news agency are treated as royalties by Argentina and may be subject to a 3% tax. [Protocol Item 3(b)]

Most favoured nation rates of royalty withholding tax

4.119     If after signature of the DTA, Argentina signs a double tax treaty with another OECD member country and the rate of source country taxation on royalties which under the proposed DTA may be taxed at a rate of 15% is less than 15%, the rate in that other DTA will apply from the entry into force of that DTA. However, the rate will not reduce below Australia’s treaty rate for royalties, being 10%. [Protocol Item 5(c)]

Definition

4.120     Generally, the definition of royalties in the DTA reflects the definition in Australia’s domestic income tax law. The substantial departure relates to technical assistance as discussed at paragraphs 4.111 to 4.115. [Paragraph 3]

Computer Software

4.121     Payments made for the right to copy or adapt the software in a manner which would, without the permission of the copyright owner, constitute an infringement of copyright, constitute royalty payments.

Other intangible property

4.122     The reference to other intangible property is an Argentine specialty. Argentina intends it to cover property such as trademarks, industrial models, patents, copyrights (including software) and topography and surveying services. [Sub-paragraph 3(a)]

4.123     Reflecting Australia’s reservation to the OECD Model and Argentine treaty practice, the definition of royalty extends to the use of or right to use industrial, commercial or scientific equipment. [Sub-paragraphs 3(b) and 3(i)]

Forbearance

4.124     Consistently with Australian tax treaty practice, sub-paragraph (j) expressly treats as royalties amounts paid or credited for forbearance to grant to third persons rights to use property covered by the Royalties article. This provision is designed to apply to arrangements along the lines of those contained in Aktiebolaget Volvo v. Federal Commissioner of Taxation (1978), 8 ATR 747; 78 ATC 4316, where instead of amounts being payable for the exclusive right to use the property, the amounts were made for the undertaking that the right to use the property would not be granted to anyone else. In the case, the amounts paid were held not to be subject to tax as a royalty payment under the terms of Article 12. [Sub-paragraph 3(j)]

Other royalties treated as business profits

4.125     As in the case of interest income, the royalty withholding tax rate limitation will not apply to royalties where the underlying property or right is effectively connected with a ‘permanent establishment’ or ‘fixed base’ in the country in which the income is sourced. The Business profits article or the Independent personal services article will apply in such cases. [Paragraph 4]

Where royalties arise

4.126     Paragraph 5 establishes where royalties arise for the purposes of paragraph 1. The rules provided for in the DTA effectively correspond, in the case of Australia, with the source rule contained in section 6C (Source of royalty income derived by a nonresident) of the ITAA 1936 for royalties paid to nonresidents. It broadly mirrors the rules for interest income contained in paragraph 6 of Article 11 ( Interest ). [Paragraph 5]

Special relationships

4.127     If royalties flow between the payer and the person beneficially entitled to the royalties as the result of a special relationship between them, the source country royalty withholding tax rate limitation will apply only to the extent that the royalties are not excessive. Any excess part of the royalty remains taxable according to the domestic law of each country tax but subject to the other provisions of the DTA. [Paragraph 6]

Article 13 - Alienation of property

Taxing rights

4.128     This article allocates between the respective countries taxing rights in relation to income, profits or gains arising from the alienation of real (immovable) property (as defined in Article 6) and other items of property.

4.129     Income, profits or gains from the alienation of real property may be taxed by the country in which the property is situated. [Paragraph 1]

Shares and other interests in land-rich entities

4.130     Paragraph 2 extends the coverage of this article to situations involving the alienation of shares or other interests in companies, and other entities, whose assets consist principally of real property (as defined in Article 6) which is situated in the other country (again, in the terms of Article 6). Such income or gains may thus be taxed by the country in which the real property is situated. This paragraph complements paragraph 1 of this article and is designed to cover arrangements involving the effective alienation of incorporated real property, or like arrangements.

4.131     This is to be the case whether the real property is held directly or indirectly through a chain of interposed entities. While not limited to chains of companies, or even chains of entities only some of which are companies, the example of chains of companies is used to make clear that the corporate veil should be lifted in examining direct or indirect ownership.

4.132     This provision responds to the tax planning opportunities exposed by the decision of the Full Federal Court in the Commissioner of Taxation v. Lamesa Holdings BV (1997) 77 FCR 597. It is designed to protect Australian taxing rights over income, profits or gains on the alienation or effective alienation of Australian real property (as defined) despite the presence of interposed bodies corporate or other entities.

4.133     On 29 May 1998 the Australian and Argentine delegations concluded a Memorandum in association with the negotiations which made the following comments in relation to this provision of the DTA:

“The 2 delegations discussed the meaning of ‘shares or comparable interests’ in a company and noted that the reference to ‘comparable interests’ seeks to avoid the technicality inherent in the word ‘share’ and will accommodate developments in equity instruments. It is intended to encompass other interests in a company which would enable the owner to effectively control the assets of the company. Examples would include share options, rights and warrants.”

[Paragraph 2]

Permanent establishment

4.134     Paragraph 3 deals with income, profits or gains arising from the alienation of property (other than real property covered by paragraph 1) forming part of the business assets of a ‘permanent establishment’ of an enterprise or pertaining to a ‘fixed base’ used for performing ‘independent personal services’. It also applies where the ‘permanent establishment’ itself (alone or with the whole enterprise) or the ‘fixed base’ is alienated. Such income or gains may be taxed in the country in which the ‘permanent establishment’ or ‘fixed base’ is situated. This corresponds to the rules for ‘business profits’ and for income from ‘independent personal services’ contained in Articles 7 and 14 respectively. [Paragraph 3]

Disposal of ships or aircraft

4.135     Income, profits or gains from the disposal of ships or aircraft operated in international traffic, or associated property (other than real property covered by paragraph 1) are taxable only in the country of resident of the operator of the ships or aircraft. This rule corresponds to the operation of Article 8 in relation to profits from the operation of ships or aircraft in international traffic.

4.136     Once the DTA enters into force this provision has effect from any year of income beginning on or after 27 September 1988, reflecting the date of signature of a Memorandum of Understanding concerning air services between Australia and Argentina - see Article 28(a)(iii)( Entry into force ). [Paragraph 4]

Capital gains ‘sweep-up’ provision

4.137     The article contains a sweep-up provision in relation to capital gains which enables each country to tax, according to its domestic law, any gains of a capital nature derived by its own residents or by a resident of the other country from the alienation of any property not specified in the preceding paragraphs of the article. It thus preserves the application of Australia’s domestic law relating to the taxation of capital gains in relation to the alienation of such property. [Paragraph 5]

Definition of real property

4.138     The term real property is to be defined for the purposes of this article as it is under Article 6. Where the property is situated is determined in accordance with paragraph 3 of Article 6. [Paragraphs 6 and 7]

Business profits

4.139     As indicated earlier, income, profits or gains from the alienation of property that fall within the scope of this article are not affected by the ‘business profits’ provisions of Article 7. In the event that the operation of this article should result in an item of income or gain being subjected to tax in both countries, the country in which the person deriving the income or gain is a resident (as determined in accordance with Article 4) would be obliged by Article 23 ( Source of income ) and Article 24 ( Methods of elimination of double taxation ) to provide double tax relief for the tax imposed by the other country.

Article 14 - Independent personal services

Taxing rights

4.140     Under this article income derived by an individual in respect of professional services or other independent activities will be subject to tax in the country in which the services or activities are performed if either:

·          the recipient has a ‘fixed base’ regularly available in that other country for the purposes of performing his or her activities; or

·          the individual is present in that country for a period or periods exceeding in the aggregate 183 days in any 12 month period commencing or ending in a fiscal period or year of income of the visited country.

4.141     If either of these conditions are met, the country in which the services or activities are performed will be able to tax so much of the income as is attributable to the activities performed during such period or periods or that are exercised from that fixed base. [Paragraph 1]

4.142     If the above tests are not met, the income will be taxed only in the country of residence of the recipient.

4.143     Remuneration derived as an employee and income derived by public entertainers are the subject of other articles of the DTA and are not covered by this article.

Article 15 - Dependent personal services

Basis of taxation

4.144     This article generally provides the basis upon which the remuneration of visiting employees is to be taxed. The provisions of this article do not apply, however, in respect of income that is dealt with separately in:

·          Article 16 ( Directors’ fees );

·          Article 18 ( Pensions and annuities );

·          Article 19 ( Government service );

·          Article 20 ( Professors and Teachers ); and

·          Article 21 ( Students );

of the DTA.

4.145     Generally, salaries, wages and similar remuneration derived by a resident of one country from an employment exercised in the other country will be liable to tax in that other country. However, subject to specified conditions, there is a conventional provision for exemption from tax in the country being visited where visits of only a short-term nature are involved. [Paragraph 1]

Short-term visit exemption

4.146     The conditions for this exemption are that:

·          the visit or visits do not exceed, in the aggregate, 183 days in any 12 month period commencing or ending in the fiscal period or year of income concerned of the visited country; and

·          the remuneration is paid by, or on behalf of, an employer who not is a resident of the country being visited; and

·          the remuneration is not deductible in determining taxable profits of a ‘permanent establishment’ or a ‘fixed base’ which the employer has in the country being visited.

Where all of these conditions are met, the remuneration so derived will be liable to tax only in the country of residence of the recipient. [Paragraphs 1 and 2]

4.147     Where a short-term visit exemption is not applicable, remuneration derived by a resident of Australia from employment in Argentina may be taxable in Argentina. However, the article does not allocate sole taxing rights to Argentina in that situation.

4.148     Accordingly, Australia would also be entitled to tax that remuneration in accordance with the general rule of the Income Tax Assessment Act 1997 (ITAA 1997) that a resident of Australia remains subject to tax on worldwide income. In common, however, with other situations where the DTA allows both countries to tax a category of income, Australia would be required in this situation (pursuant to Article 24), as the country in which the income recipient is resident for tax purposes, to relieve the double taxation that would otherwise occur.

4.149     Although that article provides for the double tax relief to be provided by Australia to be in the form of the grant of a credit against the Australian tax for the Argentine tax paid, the exemption with progression method of providing double tax relief in relation to employment income derived in the situation described would normally be applicable in practice pursuant to the foreign service income provisions of section 23AG of the ITAA 1936. This method takes into account the foreign earnings when calculating the Australian tax on other assessable income the person has derived.

Employment on a ship or aircraft

4.150     Income from an employment exercised aboard a ship or aircraft operated in international traffic may be taxed in the country of residence of the operator. [Paragraph 3]

Article 16 - Directors’ fees

4.151     Under this article, remuneration derived by a resident of one country in the capacity of a director of a company which is a resident of the other country may be taxed in the latter country.

Article 17 - Entertainers

Personal activities

4.152     By this article, income derived by visiting entertainers and sportspersons from their personal activities as such may generally be taxed in the country in which the activities are exercised, irrespective of the duration of the visit. The words ‘income derived by entertainers…from their personal activities as such…’ extend the application of this article to income generated from promotional and associated kinds of activities engaged in by the entertainer or sportsperson while present in the visited country. [Paragraph 1]

Safeguard

4.153     There is a safeguard provision included in this article which is designed to ensure that income in respect of personal activities exercised by an entertainer or sportsperson, whether received:

·          by the entertainer or sportsperson; or

·          by another person, for example, a separate enterprise which formally provides the entertainer’s or sportsperson’s services,

is taxed in the country in which the entertainer or sportsperson performs, whether or not that other person has a ‘permanent establishment’ or ‘fixed base’ in that country. [Paragraph 2]

Publicly funded entertainers

4.154     A special rule is provided for entertainers whose visit to the other country is wholly or substantially funded from public funds. In such instances the country of residence will have the sole right of taxation over income derived by entertainers. Although this exemption is not usual, a number of Australia’s DTAs provide exemptions for publicly funded entertainers. [Paragraph 3]

Article 18 - Pensions and annuities

4.155     Pensions and annuities (the term ‘annuity’ as used in this article is defined in paragraph 2) are taxable only by the country in which the recipient is resident. The article extends to government pensions, and pension and annuity payments made to dependants, for example a widow, widower, or children, of the person in respect of whom the pension or annuity entitlement accrued where, upon that person’s death, such entitlement has passed to that person’s dependants. [Paragraphs 1 and 2]

Alimony and maintenance payments

4.156     The taxing right in respect of alimony and other maintenance payments is allocated solely to the country of residence of the payer, not the recipient. The purpose of this paragraph is to remove any possibility of double taxation of such payments arising by reason of the treatment accorded such payments under the respective domestic laws. In Australia, those payments will generally be exempt from tax in the hands of the recipient and non-deductible to the payer. [Paragraph 3]

Article 19 - Government service

Salary and wage income

4.157     Salary and wage type income, other than government service pensions or annuities, paid to an individual for services rendered to a government (including a State or local authority) of one of the countries, is to be taxed only in that country. However, such remuneration is to be taxable only in the other country if:

·          the services are rendered in that other country; and

·          the recipient is a resident of that other country for the purposes of its tax, who is either:

-           a citizen of that country; or,

-           did not become a resident of that other country solely due to rendering the services.

[Paragraph 1]

Trade or business income

4.158     Remuneration for services rendered in connection with a trade or business carried on by any governmental authority referred to in paragraph 1 of the article is excluded from the scope of this article. Such remuneration will remain subject to the provisions of Article 15 ( Dependent personal services ) or Article 16 ( Directors’ fees ) as the case may be, as with any other trade or business. [Paragraph 2]

Article 20 - Professors and teachers

Exemption from source country tax

4.159     Remuneration paid to a professor or teacher who is a resident of one country and visits the other country to teach, or undertake advanced study or research will be exempted from tax in the other country where:

·          the teaching, advanced study or research is carried out at an educational institution which is mainly supported by public funds in that other country;

·          the length of the visit does not exceed in total 2 years duration;

·          the remuneration must be subject to tax in the country in which the professor or teacher is normally resident; and

·          research is not undertaken primarily for the private benefit of a specific person or persons.

[Paragraphs 1 and 2]

Article 21 - Students

Exemption from tax

4.160     This article applies to students temporarily present in one of the countries solely for the purpose of their education if the students are, or immediately before the visit were, resident in the other country. In these circumstances, the students will be exempt from tax in the country visited for payments received from abroad for their maintenance or education (even though they may qualify as a resident of the country visited during the period of their visit).

4.161     The exemption from tax provided by the visited country is treated as extending to maintenance payments received by the student that are made for maintenance of dependent family members who have accompanied the student to the visited country.

Employment income

4.162     Where however, a student from Argentina who is visiting Australia solely for educational purposes undertakes:

·          some part time work with a local employer; or

·          during a semester break undertakes work with a local employer,

the income earned by that student as a consequence of that employment may, as provided for in Article 15, be subject to tax in Australia. In this situation the payments received from abroad for the student’s maintenance or education will not however be taken into account in determining the tax payable on the employment income that is subject to tax in Australia.

Article 22 - Other income

Allocation of taxing rights

4.163     This article provides rules for the allocation between the 2 countries of taxing rights to items of income not dealt with in the preceding articles of the DTA. The scope of the article is not confined to such items of income arising in one of the countries - it extends also to income from sources in a third country.

4.164     Broadly, such income derived by a resident of one country is to be taxed only in his or her country of residence unless it is derived from sources in the other country, in which case the income may also be taxed in the other country. Where this occurs, the country of residence of the recipient of the income would be obliged by Article 24 ( Methods of elimination of double taxation ) to provide double taxation relief. [Paragraphs 1 and 2]

4.165     This article does not apply to income (other than income from real property as defined in Article 6(2)) where the right or property in respect of which the income is paid is effectively connected with a ‘permanent establishment’ or ‘fixed base’ which a resident of one country has in the other country. In such a case, Article 7 ( Business profits ) or Article 14 ( Independent personal services ), as the case may be, will apply. [Paragraph 3]

Note

4.166     This article effectively contains sweep-up provisions in relation to items of income not dealt with in other articles of the DTA and paragraph 5 of Article 13 effectively sweeps-up gains of a capital nature not dealt with in the other paragraphs of that article.

Article 23 - Source of income

Deemed source

4.167     This article effectively deems income, profits or gains derived by a resident of one country which, under the DTA, may be taxed in the other country to have a source in the latter country for the purposes of the DTA and the domestic income tax law of the respective countries. It therefore avoids any difficulties arising under domestic law source rules in respect of, for example, the exercise by Australia of the taxing rights allocated to Australia by the DTA over income derived by residents of Argentina. [Paragraph 1]

Double taxation relief

4.168     The article is also designed to ensure that where an item of income, profits or gains is taxable in both countries, double taxation relief will be given by the income recipient’s country of residence (pursuant to Article 24) for tax levied by the other country as prescribed under the DTA. In this way, income derived by a resident of Australia, which is taxable by Argentina under the DTA, will be treated as being foreign income for the purposes of the ITAA 1936, including the foreign tax credit provisions of that Act. [Paragraph 2]

Article 24 - Methods of elimination of double taxation

4.169     Double taxation does not arise in respect of income flowing between the 2 countries where the terms of the DTA provide either:

·          for the income to be taxed only in one country; or

·          where the domestic taxation law of one of the countries frees the income from its tax.

Tax credit

4.170     It is necessary, however, to prescribe a method for relieving double taxation for other classes of income which, under the DTA, remain subject to tax in both countries. In accordance with international practice, Australia’s DTAs provide for double tax relief to be provided by the country of residence of the taxpayer by way of a credit basis of relief against its tax for the tax of the country of source of the income. This article also reflects that approach.

Australian method of relief

4.171     Australia’s general foreign tax credit system, together with the terms of this article and of the DTA generally, will form the basis of Australia’s arrangements for relieving a resident of Australia from double taxation on income arising from sources in Argentina. As in the case of Australia’s other DTAs, the source of income rules specified by Article 23 for the purposes of the DTA will also apply for those purposes.

4.172     Accordingly, effect is to be given to the tax credit relief obligation imposed on Australia by paragraph 1 of this article by application of the general foreign tax credit provisions (Division 18 of Part III) of the ITAA 1936. This will include the allowance of underlying tax credit relief in respect of dividends paid by Argentine resident companies that are related to Australian resident companies, including for unlimited tiers of related companies, in accordance with the relevant provisions of the ITAA 1936.

4.173     Notwithstanding the credit basis of relief provided for by paragraph 1 of this article, the exemption with progression method of relief will be applicable, as appropriate, in relation to salary and wages and like remuneration derived by a resident of Australia during a continuous period of foreign service (as defined in subsection 23AG(7) of the ITAA 1936) in Argentina. Other foreign source income exemptions in Australia’s domestic law will also continue to be applicable in respect of relevant Argentine source income. [Paragraph 1]

Argentine relief

4.174     Argentina is required to allow its residents a deduction for Australian tax paid where they have derived income, profits or gains which are taxed in Australia and which are also subject to tax in Argentina. The deduction is of an amount equal to the Australian tax paid and is made against the Argentine tax payable on the income, subject to that deduction not exceeding an amount which bears to the total Argentine tax payable the same ratio as the income concerned bears to the total income. [Paragraph 2]

Treatment of income taxed on remittance basis

4.175     Double non taxation is avoided by ensuring that where a person’s foreign source income (or any part thereof) is taxed on a remittance basis, then the relief allowed under the DTA will apply only to the amount remitted. [ Paragraph 3]

Tax sparing

4.176     This article provides for the possibility at a future date that Australia may agree to allow tax sparing relief under the terms of the DTA. Tax sparing refers to the granting by Australia of a foreign tax credit to Australian residents for the Argentine tax forgone (i.e. the tax that would normally have been paid to Argentina but for Argentine tax incentives).

4.177     This provision was negotiated on the basis that Argentina currently provides only limited concessional tax incentives for foreign investors and that the Australian Government announced in 1997 that tax sparing would generally not be granted in future.

4.178     Any future tax sparing would be limited to manufacturing activities or exploration or exploitation of natural resources in Argentina and under Protocol Item 4(b), such a concession would only be applicable for an initial 5 year period as agreed in an exchange of letters (although this period could be extended by a further exchange of letters).

4.179     In the event that Argentina should introduce tax incentives in the specified industries and Australia declines to grant tax sparing credits, Protocol Item 4(a) recognises Argentina’s right to withhold from an Australian resident the benefit of a development incentive for which Australia declines to provide tax sparing. [Paragraph 4 and Protocol item 4]

Article 25 - Mutual agreement procedure

Consultation

4.180     One of the purposes of this article is to provide for consultation between the ‘competent authorities’ of the 2 countries with a view to reaching a satisfactory solution where a person is able to demonstrate actual or potential imposition of taxation contrary to the provisions of the DTA.

Time limits

4.181     A person wishing to use this procedure must present a case to the competent authority of the country of which the person is a resident within 3 years of the first notification of the action which the taxpayer considers gives rise to taxation not in accordance with the DTA. [Paragraph 1]

4.182     If, on consideration by the competent authorities, a solution is reached, it may be implemented irrespective of any time limits imposed by domestic tax law of the relevant country. [Paragraph 2]

Resolution of difficulties

4.183     The article also authorises consultation between the competent authorities of the 2 countries for the purpose of resolving any difficulties regarding the interpretation or application of the DTA and to give effect to it. [Paragraphs 3 and 4]

Article 26 - Exchange of information

Limitations on exchange

4.184     This article authorises and limits the exchange of information by the 2 competent authorities to information necessary for the carrying out of the DTA or for the administration of domestic laws concerning the taxes to which the DTA applies. [Paragraph 1]

4.185     The limitation placed on the kind of information authorised to be exchanged means that information access requests relating to taxes not within the coverage provided by Article 2 ( Taxes covered ), for example, sales tax, are not within the scope of the article.

Purpose

4.186     The purposes for which the exchanged information may be used and the persons to whom it may be disclosed are restricted consistently with Australia’s other DTAs. Any information received by a country shall be treated as secret in the same manner as information obtained under the domestic law of that country. [Paragraph 1]

4.187     An exchange of information that would disclose any trade, business, industrial, commercial or professional secret or trade process or which would be contrary to public policy is not permitted by the article. [Paragraph 2]

Article 27 - Members of diplomatic missions and consular posts

4.188     The purpose of this article is to ensure that the provisions of the DTA do not result in members of diplomatic and consular posts receiving less favourable treatment than that to which they are entitled in accordance with international conventions. Such persons are entitled, for example, to certain fiscal privileges under the Diplomatic (Privileges and Immunities) Act 1967 and the Consular (Privileges and Immunities) Act 1972 which reflect Australia’s international diplomatic and consular obligations.

Article 28 - Entry into force

Date of entry into force

4.189     This article provides for the entry into force of the DTA. This will be on the last date on which notes are exchanged notifying that the last of the domestic processes to give the DTA the force of law in the respective countries has been completed. In Australia, enactment of the legislation giving the force of law in Australia to the DTA along with tabling the treaty in Parliament are prerequisites to the exchange of diplomatic notes.

4.190     The DTA will have effect in Australia for withholding tax, imposed on income derived on or after 1 January in the calendar year next following that in which the DTA enters into force.

4.191     For other Australian taxes covered by the DTA, in respect of income, profits or gains of any year of income beginning on or after 1 July in the calendar year next following that in which the DTA enters into force.

4.192     The DTA will have effect in Argentina for all taxes withheld at source on income derived on or after 1 January in the calendar year next following that in which the DTA enters into force.

4.193     For other Argentine taxes covered by the DTA, in respect of tax chargeable for any tax year beginning on or after 1 January in the calendar year next following that in which the DTA enters into force.

Retrospective application

4.194     For income, profits or gains from the operation of aircraft, in respect of tax on such income, profits or gains of any year of income beginning on or after 27 September 1988.

Article 29 - Termination

4.195     By this article the DTA is to continue in effect indefinitely. However, either country may give through the diplomatic channel written notice of termination of the DTA on or before 30 June in any calendar year beginning after the expiration of 5 years from the date of its entry into force.

Cessation in Australia

4.196     In that event, the DTA would cease to be effective in Australia for purposes of withholding tax in respect of income derived on or after 1 January in the calendar year next following that in which the notice of termination is given.

4.197     For other Australian tax, it would cease to be effective in relation to income, profits or gains of any year of income beginning on or after 1 July in the calendar year next following that in which the notice of termination is given.

Cessation in Argentina

4.198     It would correspondingly cease to be effective in Argentina in respect of taxes withheld at source, for amounts paid or credited after 1 January in the calendar year next following that in which the notice of termination is given; and in relation to other Argentine tax, the termination would first apply in relation to tax chargeable for the taxable year beginning 1 January in the calendar year next following that in which the notice of termination is given.

Protocol to the DTA

4.199     The Protocol deals with a number of matters. The Protocol is expressed to be integral to the DTA and by implication commences and terminates in accordance with the DTA.

4.200     Where a Protocol item affects the application of Articles in the DTA, this impact has been included in the discussion on the relevant articles.

 



C hapter

Regulation Impact Statements

Australia-South Africa Double Taxation Agreement

1.            Specification of policy objective

5.1         The 2 key objectives of an Australia-South Africa Double Taxation Agreement (DTA) are to:

·          promote closer economic cooperation between Australia and South Africa by eliminating possible barriers to trade and investment caused by the overlapping taxing jurisdictions of the 2 countries.  A DTA would provide a reasonable element of legal and fiscal certainty within which cross-border trade and investment can be carried on; and

·          create a framework through which the tax administrations of Australia and South Africa can prevent international fiscal evasion.

2.            Background

How a DTA operates

5.2         A DTA is usually based on the OECD Model Tax Convention on Income and Capital (OECD Model), with some influences from the United Nations’ Model Double Taxation Convention between Developed and Developing Countries (UN Model).  In addition, both countries propose variations to reflect their economic interests and legal circumstances.

5.3         A DTA reduces or eliminates double taxation caused by the overlapping taxing jurisdictions because treaty partners agree (in specified situations) to limit taxing rights over various types of income.  The countries also agree on methods of reducing double taxation where both countries have a right to tax.  For example, a DTA contains a standard tax treaty provision that neither country will tax business profits derived by residents of the other country unless the business activities in the taxing country are substantial enough to constitute a permanent establishment and the income is attributable to that permanent establishment.

5.4         In negotiating the sharing of taxing rights, Australia seeks an appropriate balance between source and residence country taxing rights.  Generally the allocation of taxing rights under a DTA is similar to international practice as set out in the OECD Model, but (consistent with Australian practice) there are a number of instances where it leans more towards source country taxing rights: the definition of ‘permanent establishment’ is wider in some respects than the OECD Model, and the Business Profits, Ships and Aircraft , Royalties , Alienation of Property and Other Income Articles also give greater recognition to source country taxing rights.

5.5         In addition, a DTA provides an agreed basis for determining whether the income returned or expenses claimed on related party dealings by members of a multinational group operating in both countries can be regarded as acceptable.  This is an example of how a DTA is used to address international profit shifting.

5.6         To prevent fiscal evasion, a DTA includes an exchange of information facility.  The 2 tax administrations can also use the mutual agreement procedures to develop a common interpretation and resolve differences in application of the DTA.  There is also provision for residents of either country to instigate a mutual agreement procedure.

Australia’s Investment and Trade Relationship with South Africa

5.7         South Africa is Australia’s 21 st largest trading partner.  As at June 1998, Australia exported goods worth $A1.097 billion to South Africa and imported goods worth $A586 million from South Africa.  South Africa is Australia’s 24 th largest investment destination.  As at June 1998, the level of Australian investment in South Africa totalled $A203 million while South African investment in Australia totalled $A472 million (making South Africa Australia’s 18 th   largest source of investment income).

5.8         DTAs generally assist in improving the bilateral framework for investment and trade with South Africa and hence, generally provides a further incentive to investors.

South Africa’s tax treaty practices

5.9         As at May 1999, South Africa had concluded bilateral tax agreements with 43 countries.  In general, South Africa adheres to the OECD Model.  In addition to the income tax treaties, South Africa has concluded 7 agreements that provide for an exemption from South African income tax on income earned from international aircraft and/or vessel operations.

South Africa’s income tax system

5.10       The South African income tax system is source-based meaning that only those amounts received from a source within, or deemed to be within, South Africa are subject to South African income tax.

5.11       Individuals are taxed at progressive rates ranging between 17% and 45%. Corporations are subject to corporate income tax at the rate of 35% and are also subject to a secondary tax on any distributed profits.

5.12       South Africa imposes withholding tax at the rate of 12% of the gross amount of royalty and know-how payments to nonresidents.  South Africa does not, however, currently impose either a dividend withholding tax or interest withholding tax on such payments to nonresidents.

5.13       Fees for independent services rendered in South Africa are taxable in South Africa.  Employment income earned by nonresidents from rendering services in South Africa is also taxable in South Africa.

5.14       Pensions derived from a source within, or deemed within, South Africa are taxable in South Africa.

5.15       Branches are taxable at the corporate income tax rate on income derived from South African sources.

5.16       Nonresident individuals and companies incorporated or managed and controlled outside South Africa are taxable on 10% of the amount payable to them in respect of the embarkation of passengers, livestock, mail or goods in South Africa.

3.            Identification of implementation option(s)

5.17       The implementation options for achieving the policy objectives are:

1.       no further action - rely on existing unilateral measures; or

2.       conclude the DTA.

Option 1:  No further action - rely on existing unilateral measures

5.18       It could be argued that many of the abovementioned policy objectives will be achieved regardless of whether or not a DTA was concluded.  Many of the policy objectives have already been met to a significant extent through the internal tax laws of both the Australian and South African Governments (although both countries are of course free to amend their internal laws).  For example, unilateral enactment of foreign source income measures by Australia already provides substantial relief from juridical double taxation.  Likewise, South Africa’s income tax law provides general unilateral relief from double taxation both in the form of a deduction from, or a rebate of, the normal income tax payable by a South African resident, or by way of income tax exemptions.

Option 2:  Conclude the Double Taxation Agreement

5.19       The internationally accepted approach to meeting the above policy objectives is to conclude a bilateral DTA. [1]   A DTA would regulate the way the 2 countries will reduce double taxation, by agreeing to restrict their taxing rights in accordance with its terms.  A DTA would also record important bilateral undertakings in relation to exchange of information.

5.20       For investors, a DTA has the advantage of providing some degree of legal and fiscal certainty - unlike domestic laws which can be amended unilaterally.

5.21       As mentioned earlier, the DTA would be largely based on the OECD Model and the UN Model with some variations reflecting the economic, legal and cultural interests of the 2 countries.

4.            Assessment of impacts (costs and benefits) of each option

Impact group identification

5.22       A DTA with South Africa is likely to have an impact on:

·          Australian residents doing business with South Africa, including principally;

-           Australian residents investing directly in South Africa (especially by way of subsidiary or a branch);

-           Australian banks lending to South African borrowers;

-           Australian residents supplying technology and know-how to South African residents;

-           Australian residents exporting goods to South Africa; and

-           Australian residents supplying consultancy services to South African residents;

·          Australian employees working in South Africa;

·          people receiving pensions from the other country (although the number of cross border pension payments is understood to be minimal); and

·          the Australian Taxation Office (ATO).

Assessment of costs

Option 1:  No further action - rely on existing unilateral measures

5.23       As this option represents a continuance of the current position, it would be expected that the administration and compliance costs of this option would be minimal.  Revenue costs would also be expected to be very small.

5.24       On the other hand, even though both countries have unilaterally introduced measures to prevent double taxation of cross-border investments, this option will not resolve all areas of difference.  For example, even if both countries had very similar foreign source income measures, there could remain important differences of views over details such as source of income and residence of taxpayers.  Furthermore, this option does not protect against further unilateral changes to the internal laws and does not limit source country taxing of, for example, dividends, interest and royalties.  Similarly, so far as the tax administrations are concerned, unilateral rules do not provide a dependable long term framework for information exchange.

Option 2:  Conclude the Double Taxation Agreement

5.25       The negotiation and enactment of this DTA will cost approximately $110,000.  Most of these costs would be borne by the ATO, although other agencies, such as the Treasury, the Department of Foreign Affairs and Trade and the Australian Government Solicitor would bear some of these costs.  There will also be an unquantified cost in terms of Parliamentary time and drafting resources in enacting the proposed DTA.  In the case of this DTA, the overall costs were reduced due to the fact that the treaty was concluded only in the English language (i.e. no foreign language text required verification) and the relative speed at which both sides were able to agree on a satisfactory text.

5.26       There is a ‘maintenance’ cost to the ATO associated with DTAs in terms of dealing with enquiries, mutual agreement procedures and Advance Pricing Agreements, and OECD representation.   In some cases arrangements have emerged to exploit aspects of DTAs which have required significant administrative attention.  Of course it is unknown whether such arrangements will emerge in relation to this particular DTA.  There is therefore an unquantified cost in administering a DTA.   There will also be minor implementation costs to the ATO relating to changes in withholding tax rates.

5.27       A DTA is not expected to result in increased compliance costs for taxpayers.

5.28       There might be some reduction in Australian Government revenue from the taxation of South African investments and other business activities in Australia (because, for example, a DTA restricts source country taxation of certain items of income).  On the other hand, limitation of South African taxation rights in circumstances where Australia may have given credit for South African taxation may lead to increased Australian tax revenue.

5.29       A further consequence of the DTA is that the taxing right limitations agreed to by the 2 countries will place limits on each country’s policy flexibility in relation to cross-border taxation.  However, because Australia already has a substantial treaty network, the effect of concluding a DTA, in terms of a reduced policy flexibility, will only be marginal.

Assessment of benefits

Option 1:  No further action - rely on existing unilateral measures

5.30       This option represents the status quo.  By adopting this option there would be no need for further action and resources could be devoted to other issues.  In the domestic context, the 2 Governments would be free to act without being restricted by tax treaty obligations.

Option 2:  Conclude the Double Taxation Agreement

5.31       A DTA with South Africa would have the following broad effects:

·          Where Australians invest directly in South Africa, South Africa would not generally be able to tax an Australian resident unless the resident carries on business through a permanent establishment in South Africa.  A DTA would, to some extent, establish a basis for allocation of profits to that permanent establishment.  A DTA would also establish specific rules for taxation of shipping profits and income from real property.

·          Likewise, for Australians investing through a South African subsidiary, a DTA would set out an internationally accepted framework for dealing with parent-subsidiary transactions and other transactions between associated enterprises.  In this regard, a DTA clearly offers superior protection to the domestic rules of the 2 countries because it would provide for mutual agreement to be reached between the 2 taxing authorities.

·          To some extent, the rules embodied in a DTA would reduce the risks for Australians investing in South Africa (and vice versa) because a DTA records agreement between the 2 Governments on a framework for taxation of cross-border investments.  Especially in the case of mining investments which cannot easily be relocated, this reduction in risk may be quite important. [2]

·          A DTA would reduce South African taxation on royalties thereby making Australian suppliers of technology more competitive.  Reduction in source country taxation would also be likely to result in timing advantages for such investors, because the source country taxation is generally withheld when the income is derived, whereas residence taxation is generally taxed after the close of the financial year.  The Australian Revenue might also benefit to the extent that greater after tax profits are remitted to Australia and subject to Australian tax.  Of course there would be similar advantages in relation to South African investment in Australia.  Again, a DTA would assist Australian investors by increasing the certainty of the taxation rules applying to cross-border investment.

·          A DTA would limit the dividend withholding tax (DWT) and interest withholding tax rates which may be imposed by each country.  However, each country’s current domestic treatment of such payments means that the practical effect of such limits for Australian suppliers of capital would be minimal.  (Under its domestic law, South Africa does not currently impose a DWT [3] and only imposes tax on interest accruing to nonresidents from South African sources in very limited circumstances.  In Australia’s case, the main practical effect would be the lowering of the DWT rate imposed on unfranked dividends.)

·          Commodity exporters would be assisted in some respects because of the way a DTA would restrict the circumstances in which Australians trading with South Africa are taxed by requiring the existence of a permanent establishment in South Africa before South African taxation could take place.

·          A DTA would also assist in making clear the taxation arrangements for individual Australians working in South Africa, either independently as consultants or as employees.  Income from professional services and other similar activities provided by an individual would generally be taxed only in the country in which the recipient is resident for tax purposes.  However, remuneration derived by a resident of one country in respect of professional services rendered in the other country might be taxed in the latter country, where derived through a fixed base of the person concerned in that country, or if the person was present for more than 183 days in that country.

·          Employees’ remuneration would generally be taxable in the country where the services are performed.  However, where the services are performed during certain short visits to one country by a resident of the other country, the income would generally be exempt in the country visited.

·          There are important impacts on the Governments which are party to a DTA.  A DTA would assist the bilateral relationship by adding to the existing network of commercial treaties between the 2 countries.  As mentioned, a DTA would also promote greater cooperation between taxation authorities to prevent fiscal evasion and tax avoidance.

5.            Consultation

5.32       Information on the DTA has been provided to the States and Territories through the Commonwealth-State Standing Committee on Treaties’ Schedule of Treaty Action.

5.33       The ATO recently established an Advisory Committee of private sector representatives and tax practitioners to review draft treaties.  The DTA was submitted to this Committee for review in February 1998.

5.34       The DTA will be considered by the Parliamentary Joint Standing Committee on Treaties, which will probably provide for public consultation in its hearings.

5.35       The Treasury and the ATO monitor DTAs, as part of the whole taxation system, on an ongoing basis.  In addition, the ATO has consultative arrangements in place to obtain feedback from professional and small business associations and through other taxpayer consultation forums.

6.            Conclusion and recommended option

5.36       Present unilateral arrangements for elimination of double taxation go much of the way to satisfying the policy objectives of this measure.  However, while these arrangements provide some measure of protection against double taxation, it is clear a DTA will further reduce the possibility of double taxation - especially in relation to associated enterprises.  By establishing an internationally accepted framework for taxation of cross-border transactions it will also reduce investor risk.  In addition, the DTA reduces source country withholding taxes.  The DTA is unlikely to result in increased compliance costs for business.

5.37       There will be benefits to both Australia and South Africa in terms of improved bilateral relationships and information exchange.  On the other hand, the DTA will reduce the government’s policy flexibility.

5.38       On balance, the benefits of the proposed DTA outweigh the costs.  Option 2 is therefore recommended as the preferred option.



Protocol to the Australia-Malaysia Double Tax Agreement (DTA) and the Exchange of Letters to extend tax sparing

1.            Specification of policy objective

5.39       The 2 key objectives of the Protocol to the Australia-Malaysia Double Tax Agreement (the DTA) are to:

·          overcome the double taxation situation currently facing Australian residents who are in receipt of fees for technical services paid by Malaysian residents; and

·          ensure the tax sparing provisions of the existing DTA reflect changes in Malaysian tax incentive legislation and to extend tax sparing relief for a further period of time.  Tax sparing occurs where the tax forgone by a country in providing certain tax concessions to Australian investors is deemed to have been paid for the purposes of Australia’s foreign tax credit system (FTCS).  In the absence of tax sparing, such concessions may, in some circumstances, be negated by the FTCS which ‘tops up’ foreign taxes paid to the level of tax that would be due on an equivalent amount of domestic income.

5.40       The Protocol will also update the existing DTA in a number of respect to bring it into line with Australia’s current law and treaty policies and practices.

Background

5.41       The DTA was signed in 1980.  It contains tax sparing provisions under which Australia undertook to provide tax sparing for certain business and non-business income tax incentives provided by Malaysia under its investment promotion measures.  The DTA provided for the tax sparing provisions to apply for an initial 5 year period (which expired at the end of the 1983-1984 year of income) and for that period to be extended for any further period that may be agreed by the respective Governments in an Exchange of Letters for that purpose.

5.42       During negotiations held in July 1989, Malaysia sought Australia’s agreement to an extension of the operation of the tax sparing provisions for a further 10 years.  Those negotiations also discussed the treatment of fees for technical services income under the DTA.  Australia’s position on the taxation of fees for technical services is that such fees represent business profits and under a DTA should be taxed only by the country of residence of the recipient unless the profits are attributable to a business carried on through a permanent establishment or fixed base in the other country.  Malaysia, on the other hand, has been imposing a withholding tax of 15% (recently reduced to 10%) on the gross payments made to Australian resident taxpayers for certain managerial, technical or consultancy services utilised in Malaysia, irrespective of where the services are performed.  This impasse has led to a number of cases of unrelieved double taxation for some Australian resident taxpayers.

5.43       In order to meet the position of Australian residents who invested in Malaysia post 1983-1984, the negotiating package approved by the former Government for the July 1989 talks provided for a ‘tidy up’ of tax sparing for the income years prior to commencement of the foreign tax credit system (i.e. for the 1985, 1986 and 1987 years of income) under the existing Exchange of Letters mechanism of the DTA.  In addition, it authorised the provision of tax sparing for the revised tax incentive measures nominated by Malaysia for a further 5 year period (i.e. until the 1991-1992 year of income) as part of an amending Protocol provided that a satisfactory result could be reached with Malaysia on the fees for technical services issue.

5.44       A draft Exchange of Letters and amending Protocol to that effect resulted from the July 1989 talks but were not able to be implemented earlier because the Malaysian Cabinet did not formally approve of the fees for technical services provision of the draft Protocol until November 1992.  Further discussions were held in May 1995 in an attempt to overcome the delays and misunderstandings that had arisen in relation to earlier efforts to finalise the Exchange of Letters.  The resolution of these issues was further delayed by the sensitive diplomatic situation then existing between Australia and Malaysia.  The settlement of the last of the drafting and technical adjustments to the amending Protocol has now been settled by correspondence.

5.45       The Protocol is scheduled for signature on 2 August 1999.  An Exchange of Letters under the existing agreement to extend the operation of the tax sparing provisions until 30 June 1987 is proposed before the end of 1999.

2.            Identification of implementation option(s)

5.46       An Exchange of Letters between Australia and Malaysia and the renegotiation of the existing DTA is the only way to achieve bilateral agreement in relation to all the above objectives.

3.            Assessment of impacts (costs and benefits) of option

Impact group identification

5.47       The Protocol is likely to have an impact on:

·          Australian residents doing business with Malaysia, including principally;

-           Australian residents supplying consultancy services to Malaysian residents (at least 20 cases of double taxation of such services have been brought to the ATO’s attention);

-           Australian residents supplying technology and know-how to Malaysian residents; and

-           Australian residents investing in, lending to and receiving royalty income from Malaysia;

·          the Governments of Australia and Malaysia; and

·          the ATO and the Malaysian tax authority.

Assessment of costs

5.48       The Protocol is not expected to result in increased administration costs for the ATO because the protocol further clarifies the taxing rights of Australia and Malaysia under the existing DTA.

5.49       The Protocol is unlikely to result in increased compliance costs for business because no extra burden to comply is placed on them by the protocol.

5.50       In relation to the fees for technical services, it is unlikely there will be a cost to the Australian Revenue because in most cases the affected Australian residents will continue to be liable to tax in Australia (if they do not have a permanent establishment in Malaysia) on the fees for technical services that they provide to Malaysian residents.

5.51       It is not possible to quantify with any degree of precision the tax likely to be forgone by the Australian Revenue in providing tax sparing credits for the Malaysian tax incentives.  Much is dependent on the amount of the income subject to tax sparing, the amount of the Malaysian tax reduction or exemption applicable in respect of the particular income, the nature of the investment income, the legal structures used by Australians to make these investments, their need to remit or reinvest the income and their ability to utilise the tax spared foreign tax credits.  The presently available information and statistics are of little help in these regards.

5.52       A further complication relates to the fact that the tax sparing provisions of the protocol relate only to tax sparing granted by Malaysia for years of income up to and including the Australian year ended 30 June 1992.  The amount of likely revenue forgone will to some extent be subject to taxpayers making a claim for amendment of tax assessments issued several years ago.  The taxpayers that are likely to do this cannot be determined with any great certainty.

5.53       In relation to the period covered by the Exchange of Letters (i.e. the period from 1 July 1984 to 30 June 1987 inclusive) most foreign income was exempt from Australian tax and therefore little revenue loss would be expected to arise in relation to this period.

5.54       Subject to the above qualifications, an annual cost to Australian Revenue of around $A1 to 2 million is estimated, with the greatest cost likely to occur towards the end of the period covered by the tax sparing provisions (i.e. 30 June 1992).

5.55       It is relevant that the tax sparing measures in the proposed Exchange of Letters and amending Protocol with Malaysia were found necessary during negotiations to secure its agreement to other measures in the Protocol.  These include Malaysia limiting its taxing rights over fees derived by Australian companies for services utilised in Malaysia which will resolve a long standing dispute over unrelieved double taxation of such fees.

Assessment of benefits

5.56       Australian residents who are in receipt of fees for technical services paid by Malaysian residents will benefit because such fees will no longer be double taxed.

5.57       Clarification of which Malaysian tax laws qualify for tax sparing will reduce compliance costs for Australian investors, seeking to take advantage of the tax sparing provisions.

5.58       General improvements to the text of the DTA consistently with international best practice is expected to assist the 2 governments and their residents in interpreting the DTA.

5.59       The Protocol will further assist the development of trade and economic cooperation between Australia and Malaysia.

5.60       Resolution of the issues on fees for technical services and tax sparing in the Protocol is likely to reduce the administration costs of the ATO.

Consultation

5.61       The issues of fees for technical services and tax sparing have been consistently brought to our attention over the years by various Australian enterprises doing business in Malaysia.

5.62       Information on the Protocol and Letters has been provided to the States and Territories through the Commonwealth-State Standing Committee on Treaties’ Schedule of Treaty Action.

5.63       The ATO recently established an Advisory Committee of private sector representatives and tax practitioners to review draft treaties.  The Protocol was submitted to this Committee for review in February 1998.

5.64       The Protocol will be considered by the Parliamentary Joint Standing Committee on Treaties, which will probably provide for public consultation in its hearings.

4.            Conclusion

5.65       The Protocol would stop the double taxation of Australian residents who are in receipt of fees for technical services paid by Malaysian residents.

5.66       The Protocol will clarify the operation of the tax sparing provisions of the existing DTA.

5.67       The Protocol is unlikely to result in increased compliance costs for business because no extra burden to comply is placed on them by the Protocol.

5.68       The Treasury and the ATO will monitor this Protocol, as part of the whole taxation system, on an ongoing basis.  In addition, the ATO has consultative arrangements in place to obtain feedback from professional and small business associations and through other taxpayer consultation forums.



Australia-Slovak Republic Double Tax Agreement

1.            Specification of policy objective

5.69       The 2 key objectives of the Australia-Slovak Republic Double Tax Agreement (DTA) are to:

·          promote closer economic cooperation between Australia and the Slovak Republic by eliminating possible barriers to trade and investment caused by the overlapping taxing jurisdictions of the 2 countries.  A DTA would provide a reasonable element of legal and fiscal certainty within which cross-border trade and investment can be carried on; and

·          create a framework through which the tax administrations of Australia and the Slovak Republic can prevent international fiscal evasion.

2.            Background

How a DTA operates

5.70       Australian tax treaties are usually based on the OECD Model.  There are also some influences from the UN Model.  In addition, both countries have proposed some minor variations to reflect their economic interests and legal circumstances.

5.71       A DTA reduces double taxation caused by the overlap of taxing jurisdictions because treaty partners agree to limit their taxing rights over various types of income.  The countries also agree on methods of reducing double taxation where both countries have a right to tax.  For example, a DTA contains a standard tax treaty provision that neither country will tax business profits derived by residents of the other country unless the business activities in the taxing country are substantial enough to constitute a permanent establishment and the income is attributable to that permanent establishment.

5.72       In negotiating the sharing of taxing rights, Australia seeks an appropriate balance between source and residence country taxing rights.  Generally the allocation of taxing rights under a DTA is similar to international practice as set out in the OECD Model, but (consistent with Australian practice) there are a number of instances where it leans more towards source country taxing rights: the definition of ‘permanent establishment’ is wider in some respects than the OECD Model, and the Business Profits, Ships and Aircraft , Royalties, Alienation of Property and Income Not Expressly Mentioned Articles also give greater recognition to source country taxing rights.

5.73       In addition, a DTA provides an agreed basis for determining whether the income returned or expenses claimed on related party dealings by members of a multinational group operating in both countries can be regarded as acceptable.  This is an example of how a DTA is used to address international profit shifting.

5.74       To prevent fiscal evasion, a DTA includes an exchange of information facility.  The 2 tax administrations can also use the mutual agreement procedures to develop a common interpretation and resolve differences in application of the DTA.  There is also provision for residents of either country to instigate a mutual agreement procedure.

Australia’s Investment and Trade Relationship with the Slovak Republic [4]

5.75       So far as Australia is concerned, the main impact of the DTA will be on Australian enterprises investing in and trading with the Slovak Republic.  In 1998-1999 Australia exported products totalling $A4.2 million, with the major exports being wool, bovine meat and computers.  In the same period Australia’s imports from the Slovak Republic totalled $A8.2 million, with the major imports being computer parts, nitrogen-function compounds and articles of plastics.  Even though Australia’s current investment and trade relationship with the Slovak Republic is not substantial, this treaty should assist in improving the bilateral framework for investment and trade with the Slovak Republic.

3.            Identification of implementation option(s)

5.76       The implementation options for achieving the policy objectives are:

1.       no further action - rely on existing unilateral measures; or

2.       conclude the DTA.

Option 1:  No further action - rely on existing unilateral measures

5.77       If a DTA is not concluded with the Slovak Republic, some of the policy objectives sought to be achieved by means of a DTA may nevertheless be achieved through the domestic tax laws of both the Slovak and Australian Governments - although both countries are free to amend their internal laws.  Essentially, DTA policy objectives are achieved by:

·          allocating taxing rights over various classes of income, profits and gains between the Contracting States on the basis of source or residency;

·          specifying the methods to be used in providing relief from double taxation where both countries have a taxing right;

·          facilitating the prevention of fiscal evasion by specifying the circumstances in which information may be exchanged while at the same time according that information the same protection from disclosure that applies under the relevant domestic law; and

·          providing a mechanism to allow taxpayers who consider that the taxation treatment has not been in accordance with the terms of a DTA to invoke procedures which require the relevant tax authorities to try to agree on resolving the issue.

5.78       Where the domestic law provides a credit for foreign tax paid on foreign income, the double tax relief can be substantially achieved without a DTA.  For example, where income derived by a taxpayer is subject to tax in both the country of residence and the source country Australia’s foreign tax credit system provides relief from such juridical double taxation.  However, a DTA guarantees that double tax relief will continue to be provided by both countries.

Option 2:  Conclude the DTA

5.79       The internationally accepted approach to meeting the above policy objectives is to conclude a bilateral DTA [5] .  A DTA would regulate the ways in which 2 countries will reduce double taxation by agreeing to the terms under which they will restrict their taxing rights over various types of income.  A DTA may also record important bilateral undertakings in relation to exchange of information which can be of considerable assistance in preventing fiscal evasion.

5.80       For business and investors generally a DTA has the advantage of providing some degree of legal and fiscal certainty - unlike domestic laws which can be amended unilaterally.

5.81       As mentioned earlier, a DTA would be largely based on the OECD Model Tax Convention and the UN Model, with some mutually agreed variations reflecting the economic, legal and cultural interests of the 2 countries.

4.            Assessment of impacts (costs and benefits) of each option

Impact group identification

5.82       A DTA with the Slovak Republic is likely to have an impact on:

·          Australian residents doing business with the Slovak Republic, including principally;

-           Australian residents investing directly in the Slovak Republic (either by way of a subsidiary or a branch);

-           Australian banks lending to Slovak borrowers;

-           Australian residents supplying technology and know-how to residents of the Slovak Republic;

-           Australian residents exporting to the Slovak Republic; and

-           Australian residents supplying consultancy services to residents of the Slovak Republic;

·          Australian employees working in the Slovak Republic;

·          people receiving pensions from the other country (although the number of cross border pension payments is understood to be minimal); and

·          the ATO.

Assessment of costs

Option 1:  No further action - rely on existing unilateral measures

5.83       As this option represents a continuance of the current position, it would be expected that the administration and compliance costs of this option would be minimal.  Revenue costs would also be expected to be very small.

5.84       On the other hand, even though both countries have unilaterally introduced measures to prevent double taxation of cross-border investments, this option will not resolve all areas of difference.  For example, even if both countries had very similar mechanisms for allowing credit for foreign tax paid differences could arise over fundamental matters such as the source of income and residence of taxpayers.  Furthermore this option does not protect against further unilateral changes to the internal laws and does not limit source country taxing of, for example, dividends, interest and royalties.

5.85       In addition, investors are concerned that unilateral tax laws do not provide the longer term certainty desirable for making substantial long term investments offshore.  This is because the Governments of either State can vary key tax conditions unilaterally.  Similarly, so far as the tax administrations are concerned, unilateral rules do not provide a dependable long term framework for the exchange of information.

Option 2:  Conclude the DTA

5.86       The negotiation and enactment of this DTA will cost approximately $120,000.  Most of these costs would be borne by the ATO, although other agencies, such as Treasury, the Department of Foreign Affairs and Trade and the Australian Government Solicitor would bear some of these costs.  There will also be an unquantifiable cost in terms of Parliamentary time and drafting resources in enacting the proposed DTA.

5.87       There is a ‘maintenance’ cost to the ATO associated with DTAs in terms of dealing with enquiries, mutual agreement procedures and advance pricing agreements, and OECD representation.  In some cases arrangements have emerged to exploit aspects of DTAs which have required significant administrative attention.  Of course it is unknown whether such arrangements will emerge in relation to this particular DTA.  There is therefore an unquantified cost in administering a DTA.  There will also be minor implementation costs to the ATO in relation to changes in withholding tax rates.

5.88       A DTA is not expected to result in increased compliance costs for taxpayers.

5.89       There might be some reduction in Australian Government revenue from the taxation of Slovak investments and other business activities in Australia (because, for example, the DTA restricts source country taxation of certain items of income).  On the other hand, limitation of Slovak taxation rights in circumstances where Australia may have given credit for Slovak taxation may lead to increased Australian tax revenue.  Given the small investment and trade relationship between our 2 countries, the revenue cost is not expected to be significant.

5.90       However, it should also be recognised that the limitations agreed to by the 2 Contracting States, places limits on their policy flexibility in relation to cross-border taxation.  But because Australia already has a substantial treaty network, the cost of a DTA in terms of reduced policy flexibility will only be marginal.

Assessment of benefits

Option 1:  No further action - rely on existing unilateral measures

5.91       This option represents the status quo.  If this option were adopted there would be no need for further action and resources could be devoted to other issues.  In the domestic context the 2 Governments would be free to act without being restricted by treaty obligations.

Option 2:  Enter into a DTA

5.92       A DTA with the Slovak Republic would have the following broad effects:

·          Where Australian businesses invest directly in the Slovak Republic or provide services in that country, the Slovak Republic will not generally be able to tax the profits unless the Australian enterprise carries on business through a permanent establishment in the Slovak Republic.  In the case of the furnishing of services this will generally be the case where the services are provided for longer than 6 months.  A DTA would, to some extent, establish a basis for the allocation of profits to that permanent establishment.  A DTA would also establish specific rules for taxation of airline and shipping profits and income from real property.

Similarly, for Australians investing through a Slovak subsidiary, a DTA would set out an internationally accepted framework for dealing with parent-subsidiary transactions and other transactions between associated enterprises.  In this regard a DTA clearly offers superior protection compared to the domestic rules of the 2 countries, because it provides for mutual agreement to be reached between the 2 taxing authorities.

To some extent, the rules embodied in a DTA will reduce the risks for Australians investing in the Slovak Republic (and vice versa) because a DTA records agreement between the 2 Governments on a framework for taxation of cross-border investments.

Furthermore, it is only in the context of a DTA [6] that the Slovak Republic will agree to limit domestic withholding taxes on interest and royalties.  (Australia reduces royalty and certain dividend withholding taxes under its DTAs.)

·          A DTA would reduce Slovak taxation on interest and royalties thereby making Australian suppliers of capital and technology more competitive.  Reduction in taxation at source would also be likely to result in timing advantages for such investors because source country taxation is generally imposed at the time the income is derived, whereas residents are generally taxed by assessment on income derived during a financial year after the end of that financial year.  The Australian revenue might also benefit to the extent that greater after tax profits are remitted to Australia and subject to Australian tax.  Of course, there are similar advantages in relation to Slovak investments in Australia.  Again a DTA would assist Australian investors by increasing the certainty of the taxation rules applying to cross-border investment.

·          Commodity exporters would be assisted in some respects because of the way a DTA would restrict the circumstances in which Australians trading with the Slovak Republic are taxed by requiring the existence of a permanent establishment in the Slovak Republic before Slovak taxation could take place.  However, in practice this benefit would not be great because the Slovak Republic’s domestic taxing rules adopt a similar approach and, existing commodity exports to the Slovak Republic are only modest.

·          A DTA would also assist in making clear the taxation arrangements for individual Australians working in the Slovak Republic, either independently as consultants or as employees.  Income from professional services and other similar activities provided by an individual would generally be taxed only in the country in which the recipient is resident for tax purposes. However, income derived by a resident of one country in respect of professional services rendered in the other country might be taxed in the latter country where the services are attributable to a fixed base that is regularly available in that country.

·          Employees’ remuneration would generally be taxable in the country where the services are performed.  However, where the services are performed during certain short visits to one country by a resident of the other country, the income would generally be exempt in the country visited.

·          There are important impacts on the countries which are party to a DTA.  As mentioned the revenue impact for the Australian Government is not expected to be significant.  A DTA would assist the bilateral relationship by adding to the existing network of commercial treaties between the 2 countries.  As mentioned, a DTA would also promote greater cooperation between taxation authorities to prevent fiscal evasion and tax avoidance.

5.            Consultation

5.93       Information on the DTA has been provided to the States and Territories through the Commonwealth-State Standing Committee on Treaties’ Schedule of Treaty Action.

5.94       The ATO recently established an Advisory Panel of private sector representatives and tax practitioners to review draft treaties.  The DTA was submitted to this Committee for review in February 1998.

5.95       The DTA will be considered by the Parliamentary Joint Standing Committee on Treaties, which will probably provide for public consultation in its hearing.

5.96       The Treasury and the ATO monitor DTAs, as part of the whole taxation system, on an ongoing basis.  In addition the ATO has consultative arrangements in place to obtain feedback from professional and small business associations and through other taxpayer consultation forums.

6.            Conclusion and recommended option

5.97       Present unilateral arrangements for elimination of double taxation go much of the way towards satisfying the policy objectives of this measure.  However, while these arrangements provide some measure of protection against double taxation, it is clear a DTA will further reduce the possibility of double taxation, especially in relation to associated enterprises.  By establishing an internationally accepted framework for the taxation of cross-border transactions it will also reduce investor risk.  In addition, a DTA will also reduce source country withholding taxes on dividends, interest and royalties.  A DTA is unlikely to result in increased compliance costs for business.

5.98       There will be benefits to both Australia and the Slovak Republic in terms of improved bilateral relationships and information exchange.  On the other hand the DTA will reduce the governments’ policy flexibility.

5.99       On balance, the benefits of the proposed DTA outweigh the costs.  Option 2 is therefore recommended as the preferred option.



Australia-Argentina Double Tax Agreement

1.            Specification of policy objective

5.100     The 2 key objectives of the Australia-Argentina Double Tax Agreement (the DTA) are to:

·          promote closer economic cooperation between Australia and Argentina by eliminating possible barriers to trade and investment caused by the overlapping taxing jurisdictions of the 2 countries; and

·          create a framework through which the tax administrations of Australia and Argentina can prevent international fiscal evasion.

5.101     In the pursuit of these objectives, the DTA will provide a reasonable element of legal and fiscal certainty within which cross border and trade investments can be carried on.

2.            Background

How the DTA operates

5.102     The proposed treaty is based on the OECD Model.  There are also some influences from the UN Model.  In addition both countries have proposed variations to reflect their economic interests and legal circumstances.

5.103     The DTA will reduce or eliminate double taxation caused by the overlapping taxing jurisdictions, because under the treaty Australia and Argentina agree (in specified situations) to limit taxing rights over various types of income.  The countries also agree on methods of reducing double taxation where both countries have a right to tax.  For example, the DTA contains the standard tax treaty provision that neither country will tax business profits derived by residents of the other country unless the business activities in the taxing country are substantial enough to constitute a permanent establishment and the income is attributable to a permanent establishment (Article 7).

5.104     In negotiating the sharing of taxing rights, Australia seeks an appropriate balance between source and residence country taxing rights.  Generally the allocation of taxing rights under the DTA is similar to international practice as set out in the OECD Model, but (consistently with Australian practice) there are a number of instances where it is biased more towards source country taxing rights: the definition of ‘permanent establishment’ is wider in some respects than the OECD Model, and the Business Profits, Royalties , Ships and Aircraft , Alienation of Property and Other Income Articles also give greater recognition to source country taxing rights.  Furthermore, Argentine taxing rights over certain fees for technical services are wider than the OECD or UN standards.

5.105     In addition, the DTA provides an agreed basis for determining whether the income returned or expenses claimed on related party dealings by members of a multinational group operating in both countries can be regarded as acceptable. (Articles 7 and 9)

5.106     The operation of Articles 7 and 9 in this respect, also provides an example of how the DTA is used to address international profit shifting.  To prevent fiscal evasion, the DTA includes an exchange of information facility.  In addition, the 2 tax administrations can use the mutual agreement procedures to develop a common interpretation and resolve differences in application of the DTA.

Australia’s Investment and Trade Relationship with Argentina [7]

5.107     So far as Australia is concerned, the main impact of a DTA will be on Australian enterprises investing in and trading with Argentina .  While trade between the 2 countries remains modest, 2 way trade at around $A244 million in the 1998 year, Australian investment in Argentina is significant.

5.108     Australian investors have mainly targeted mining resulting in Australia being the third largest investors in the industry.  There are numerous Australian companies involved, working under exploration leases and evaluating projects, with the most significant operation being a $US1 billion MIM/North project to develop copper and gold deposits in the province of Catamarca.

5.109     Australian investors are also active in upgrading and operating the largest container terminal in the port of Buenos Aires, as well as being involved in cold storage, ship brokering, multiplex cinema complexes and banking.  Qantas has initiated direct flights from Australia to Buenos Aires and Prime television has become the first foreign investor in Argentine free-to-air television through their joint venture with a local media group which purchased Argentina Channel 9.  Other companies currently engaged in trade and investment in Argentina are: BHP, ANZ, Western Mining, LIAG, P&O Australia, Village Roadshow, Hoyts and the Australian Geographical Survey Organisation [8] .

3.            Identification of implementation option(s)

5.110     In analysing the advantages and disadvantages of the proposed tax treaty, 2 implementation options are considered below:

1.  no further action - rely on existing unilateral measures; or

2.  conclude the double tax agreement

Option 1:  No further action - rely on existing unilateral measures

5.111     If nothing was done - i.e. the DTA was not concluded - it could be argued that many of the above policy objectives will nevertheless be achieved.  Many of the policy objectives have already been met to a significant extent through the internal tax laws of both the Argentine and Australian Governments.  For example unilateral enactment of foreign source income measures by Australia already provides substantial relief from juridical double taxation.  Likewise it can be argued that Australian law already permits exchange of information with the Argentine tax administration.

Option 2:  Conclude the Double Taxation Agreement

5.112     The internationally accepted approach to meeting the above policy objectives is to conclude a bilateral DTA. [9]   The DTA regulates the way the 2 countries will reduce double taxation, by agreeing to restrict their taxing rights in accordance with its terms.  The DTA also records important bilateral undertakings in relation to exchange of information.

4.            Assessment of impacts (costs and benefits) of each option

Impact group identification

5.113     The DTA is likely to have an impact on:

·          Australian residents doing business with Argentina, including principally;

-           Australian residents investing directly in Argentina (either by way of subsidiary or a branch);

-           Australian banks lending to Argentine borrowers;

-           Australian residents supplying technology and know-how to Argentine residents;

-           Australian residents exporting to Argentina; and

-           Australian residents supplying consultancy services to Argentine residents;

·          Australian employees working in Argentina;

·          people receiving pensions from the other country (although the number of cross border pension payments is understood to be minimal.); and

·          the ATO.

Assessment of costs

Option 1:  No further action - rely on existing unilateral measures

5.114     Because this option can be largely achieved by doing nothing, it would be expected that the administration and compliance costs of this option would be minimal.  Revenue costs would also be expected to be very small.  On the other hand, even though both countries have unilaterally introduced measures to prevent double taxation of cross-border investments, this option will not resolve all areas of difference; for example, Argentina imposes a tax on technical services income sourced in Australia, which, in the absence of a DTA will be double taxed.  Furthermore, investors are concerned that unilateral tax laws do not provide the longer term certainty desirable for making substantial long term investments offshore.  This is because the Governments of either State can vary key tax conditions unilaterally.  Similarly, so far as the tax administrations are concerned, unilateral rules do not provide a dependable long term framework for information exchange.

Option 2:  Conclude the Double Taxation Agreement

5.115     The negotiation and enactment of this DTA will cost approximately $130,000.  Most of these costs will be borne by the ATO, although other agencies, such as Treasury, the Department of Foreign Affairs and Trade and the Australian Government Solicitor will bear some of these costs.  There will also be an unquantified cost in terms of Parliamentary time and drafting resources in enacting the proposed DTA.

5.116     There is a ‘maintenance’ cost to the ATO associated with DTAs in terms of dealing with enquiries, mutual agreement procedures and advance pricing agreements, and OECD representation.  In some cases arrangements have emerged to exploit aspects of DTAs which have required significant administrative attention.  Of course it is unknown whether such arrangements will emerge in relation to this particular DTA.  There will also be minor implementation costs to the ATO in relation to changes in withholding tax rates.

5.117     The DTA is not expected to result in increased compliance costs for taxpayers.

5.118     There may be some reduction in Australian Government revenue from taxation of Argentine investments and other business activities in Australia (because the treaty restricts source country taxation of certain items of income and certain Argentine taxes which are not currently creditable will be deemed creditable following the conclusion of a DTA).  On the other hand, limitation of Argentine taxation rights in circumstances where Australia may have given credit for Argentine taxation may lead to increased Australian tax revenue - especially in relation to interest and fees for technical services.

5.119     However, it should also be recognised that the limitations agreed to by the 2 Contracting States under the DTA, limits flexibility of their policy in relation to cross-border taxation.  However, as Australia already has a substantial treaty network the conclusion of the proposed DTA, in terms of a reduced policy flexibility, will only be marginal.

Assessment of benefits

Option 1:  No further action - rely on existing unilateral measures

5.120     This option represents the status quo.  By adopting this option there would be no need for further action and resources could be devoted to more significant issues.  In the domestic context the 2 Governments would be free to act without being restricted by treaty obligations.

Option 2:  Conclude the Double Taxation Agreement

5.121     The proposed DTA will have the following broad effects:

·          As mentioned, the current level of Australian investment in Argentina is substantial and mainly concentrated in the mining sector.

·          Where Australians invest directly in Argentina, Argentina will not generally be able to tax the Australian resident unless the resident carries on business through a permanent establishment in Argentina.  The treaty will, to some extent, establish a basis for allocation of profits to that permanent establishment.  The DTA also establishes specific rules for taxation of shipping profits and income from real property.

Likewise for Australians investing through an Argentine subsidiary, the treaty will set out an internationally accepted framework for dealing with parent-subsidiary transactions and other transactions between associated enterprises.  In this regard the DTA clearly offers superior protection to the domestic rules of the 2 countries, because it provides for mutual agreement to be reached between the 2 taxing authorities.

To some extent, the rules embodied in the DTA will reduce the risks for Australians investing in Argentina (and vice versa) because the DTA records agreement between the 2 Governments on a framework for taxation of cross-border investments.  Especially in the case of mining investments which cannot easily be relocated, this reduction in risk may be quite important. [10]

The treaty will reduce Argentine taxation on royalties thereby making Australian suppliers of technology more competitive.  Most royalty withholding taxes will fall from 24% to 10% or 15%. The DTA will limit taxation of dividends paid to Australian shareholders.

In practice no dividend withholding taxes are currently imposed in Argentina, but there are proposals to introduce a tax on dividends.  Thus, Australian suppliers of capital will remain competitive if dividend withholding taxes are introduced.  Reduction in source country taxation is also likely to result in timing advantages for such investors, because the source country taxation is generally withheld when the income is derived, whereas residence taxation is generally taxed after the close of the financial year.  It is anticipated that the Australian revenue may also benefit to the extent that greater after tax profits are remitted to Australia and subject to Australian tax.  Of course there are similar advantages in relation to any Argentine investment in Australia.  Again the DTA will assist Australian investors by increasing the certainty of the taxation rules applying to cross-border investment.

·          Commodity exporters are assisted in some respects because of the way the treaty will restrict the circumstances in which Australians trading with Argentina will be taxed by requiring the existence of a permanent establishment in Argentina before Argentine taxation will take place.  Although it should be noted that existing commodity exports to Argentina are only modest at $A118 million in the 1997 year.

·          The treaty will also assist in making clear the taxation arrangements for individual Australians working in Argentina, either independently as consultants or as employees.  Income from professional services and other similar activities provided by an individual will generally be taxed only in the State in which the recipient is resident for tax purposes. However, remuneration derived by a resident of one State in respect of professional services rendered in the other State may be taxed in the latter State, where derived through a fixed base of the person concerned in that State, or if the person is present for more than 183 days in that State.

Notwithstanding the above, the DTA permits Argentina to impose a contractors withholding tax on payments of technical services fees by Argentine residents.  This right extends to payments for services which may technically be Australian sourced. However, the DTA reduces the (monetary) rates from 18% to 27% of gross payments to 10% of net fees.

Employee’s remuneration will generally be taxable in the State where the services are performed.  However, where the services are performed during certain short visits to one State by a resident of the other State, the income will generally be exempt in the State visited.

·          Similar to other DTAs, the treaty contains the facility by which in an exchange of letters between relevant ministers of the 2 Governments, individual Argentine tax incentives may be tax-spared.  Tax sparing is a system of relief under which Australia would recognise tax forgone by Argentina under its development incentives for foreign tax credit purposes.  No incentives have been nominated by Argentina and it is current Australian Government policy generally not to agree to tax sparing.

·          The most favoured nation clause of the DTA ensures that if Argentina were to subsequently enter into another treaty with a third party with more favourable tax rates for dividends, interest, royalties or contractors withholding taxes, the corresponding tax rate in the DTA would automatically be reduced to coincide with the greater of the lower rate or the set minimum limit.

·          There are important impacts on the Governments which are party to the DTA.  The DTA will assist the bilateral relationship by adding to the existing network of commercial treaties between the 2 countries.  As mentioned the DTA will promote greater cooperation between taxation authorities to prevent fiscal evasion and tax avoidance.

5.            Consultation

5.122     Information on the DTA has been provided to the States and Territories through the Commonwealth-State Standing Committee on Treaties’ Schedule of Treaty Action.

5.123     The ATO established an Advisory Panel of private sector representatives and tax practitioners to review draft treaties before enactment.  In February and March 1999 members of the Panel provided comments on this DTA and issues of concern were later clarified by the ATO via email and telephone communications.

5.124     The DTA will be subject to scrutiny by the Joint Standing Committee on Treaties, which will probably provide for public consultation in its hearing.  This body is charged with the task of examining and reporting to the Parliament on matters arising from treaties or other international instruments.

5.125     The Treasury and the ATO will monitor this DTA, as part of the whole taxation system, on an ongoing basis.  In addition the ATO has consultative arrangements to obtain feedback from professional and small business associations and through other taxpayer consultation forums.

6.            Conclusion and recommended option

5.126     Present unilateral arrangements for elimination of double taxation go much of the way to satisfying the policy objectives of this measure.  However, while these arrangements provide some measure of protection against double taxation, it is clear the DTA will further reduce the possibility of double taxation - especially in relation to associated enterprises and consultancy fees.  By establishing an internationally accepted framework for taxation of cross-border transactions it will also reduce investor risk.  It also reduces certain Argentine withholding taxes.  The DTA is unlikely to result in increased compliance costs for business.

5.127     There will be benefits to both Australia and Argentina in terms of improved bilateral relationships and information exchange.  On the other hand the DTA will reduce the governments’ policy flexibility.

5.128     On balance the benefits of the proposed DTA outweigh the costs. The DTA should be enacted.

 

 



 




[1] Possibly reflecting the widely differing economic interests and tax law structures of countries, there are very few multilateral tax treaties.

[2] A common theme in relation to Australian offshore investment is that a DTA would reduce investor risks by putting in place an agreed framework for taxation of cross-border activities which would prevent double taxation.  However, it should be noted that a DTA is not guaranteed to always prevent double taxation.  For example, the definition given to certain terms by the internal law of the 2 countries may result in cases where the treaty allocates the same taxing rights over the same income to both countries.  This is a problem with all tax treaties based on the OECD Model.

On the other hand, because a DTA is largely based on standard international tax models (which have a body of supporting commentaries) it can be said there is a common international understanding of the meaning of many of its provisions.  In addition, a DTA would contain procedures to enable the 2 governments to mutually agree on matters of interpretation and application to prevent double taxation.

[3] Instead of imposing a DWT on dividend payments to shareholders, South Africa imposes a secondary tax on companies on declaration of dividends.  The secondary tax is imposed in addition to the corporate tax and is currently imposed at the rate of 12.5% of net dividends (i.e. dividends declared less dividends received).

[4] Source: Department of Foreign Affairs and Trade.

[5]   Possibly reflecting the widely differing economic interests and tax law structures of countries, there are very few multilateral tax treaties.

[6] The requirement for bilateral agreement on reduction of source country taxation is understandable because both countries wish to be assured of reciprocal treatment of their residents.

[7] Source: Department of Foreign Affairs and Trade

[8] Comprehensive details of the quantum of these investments are currently unavailable.

[9] Possibly reflecting the widely differing economic interests and tax law structures of countries, there are very few multilateral tax treaties.

[10] A common theme in relation to all Australian activity in Argentina is that the DTA will reduce investor risks by putting in place an agreed framework for taxation of cross-border activities which will prevent double taxation.  However, it should be noted that a DTA is not guaranteed to always prevent double taxation.  For example, the definition given to certain terms by the internal law of the 2 countries may result in cases where the treaty allocates the same taxing rights over the same income to both countries.  This is a problem with all tax treaties based on the OECD Model.

On the other hand because the  proposed DTA is largely based on standard international tax models (which have a body of supporting commentaries) it can be said there is a common international understanding of the meaning of many of its provisions.  In addition it contains procedures to enable the 2 governments to mutually agree on matters of interpretation and application to prevent double taxation.